The European Central Bank will continue cutting interest rates as the inflation spike in recent years has increasingly moved into the rear-view mirror, bringing the 2% target.
The mentioned statement was made by the President of the European Central Bank, Christine Lagarde, on Monday, December 16. She also noted that after a long period of restrictive monetary policy, the accuracy of economic forecasts has improved. According to her, European Central Bank officials can now focus on managing future risks instead of worrying about the transmission of past shocks.
Moreover, Christine Lagarde said that inflation in the service sector, which is still elevated, will ease in the coming months. According to her, the European financial regulator is already close to its target, but the corresponding indicator is not yet what can be called a realized reality. She said that if the incoming data continues to confirm the European Central Bank’s baseline, the direction of travel is clear. According to her, the financial regulator expects further lowering of the cost of borrowing.
It is worth noting that the eurozone has already made significant progress in countering inflation. At the beginning of the current year, the corresponding indicator even dropped below the 2% mark. Since then, inflation has returned to a growth trajectory, although the corresponding process has not demonstrated critical or catastrophic proportions. Currently, the European Central Bank expects some fluctuations within the framework of the dynamic of inflation. The financial regulator assumes that after the mentioned stage, inflation will be fixed at the target level. It is worth noting that in the relevant context, the European Central Bank implies a stable indicator and not a kind of temporary outbreak in the form of a fleeting achievement of the goal followed by a movement in the opposite direction.
Christine Lagarde said that the domestic inflation is still too high, but the price momentum in the service sector has dropped steeply recently. According to her, the latest data suggests that there is scope for a downward adjustment in services inflation, and therefore domestic inflation, in the coming months. She also said that the European Central Bank tracker sees wage growth slowing to about 3% next year. According to her, this indicator corresponds to the goal of the financial regulator.
The European Central Bank has already cut interest rates four times this year. At the same time, even against the background of appropriate actions within the framework of monetary policy easing, the financial regulator adheres to the opinion that the cost of borrowing at its current level still constrains economic activity. The corresponding position clearly signals a high probability of further lowering the cost of borrowing. Most officials of the European Central Bank argue that monetary policy can gradually move towards a neutral setting. In this case, it means a level of borrowing costs that does not limit and at the same time does not stimulate economic growth. According to bets on the money markets, the corresponding point can be reached as early as the middle of next year.
There is a kind of consensus opinion among officials, according to which the eurozone’s economic system continues to face difficulties. At the same time, companies and households are hesitant to spend money amid high levels of uncertainty. In this context, it is worth noting that significant uncertainty is currently characteristic of the global economy as a whole, and does not belong to the category of regional problems. The corresponding situation is likely to continue to be relevant in the near future, as tensions in the geopolitical space are increasing and do not show signs of easing at least in the near term. Cooperation between some of the world’s capitals is on a downward trajectory. Moreover, the intentions of Donald Trump, who will return to the White House in January, to increase tariffs on goods imported into the United States, if implemented, will significantly increase tensions in the global trade space, which will also have certain political consequences. According to experts, the increase in tariffs is likely to affect the eurozone. So far, this is a potential scenario, but its realism is far from minimal.
The European Central Bank predicts that economic growth in the eurozone will be 1.1% next year. At the same time, the current geopolitical situation, which is not favorable, contains a significant probability that the mentioned indicator will eventually fall below the expectations of the financial regulator. Political turbulence in France and Germany against the background of the resignation of local governments, uncertainty related to the re-election of Donald Trump following the election of the president of the United States, and ongoing armed conflicts in different regions of the world are negative factors in terms of the prospects for the eurozone economy.
While services performed better in December, S&P Global’s Composite Purchasing Managers’ Index remained at the level indicating the shrinking of the private sector in the eurozone.
Christine Lagarde stated that the main reason for softer activity lately is the lackluster domestic recovery and a striking inertia in private consumption. She noted that household pessimism about real incomes should dissipate as high inflation becomes more and more a thing of the past. At the same time, Christine Lagarde warned that growing geopolitical uncertainty could form new dents in household sentiment.
Analysts quoted by the media predict that in the eurozone it will consistently lower the cost of borrowing until the deposit rate is fixed at 2%. Investors are pricing the possibility of large-scale actions by the European Central Bank on the appropriate path. It is worth noting separately that some officials do not exclude such a possibility. European Central Bank Governing Council member Martins Kazaks stated that the scale of interest rate cutting can be expanded if economic developments warrant it. Also in this context, it was separately noted that shock factors, including the geopolitical situation and wars, can form a new impetus for inflation.
Luis de Guindos, Vice President of the European Central Bank, said that the path of interest rates is clear, as inflation is likely to converge to 2%.
It is worth noting that the mentioned financial regulator currently adheres to an approach that provides for decision-making regarding the dynamic of borrowing cost based on incoming data on the state of affairs in the economy. The Federal Reserve also operates under a similar approach.
Currently, the prospects for the eurozone economy are what can be described as a kind of hypothetical optimism that will struggle not to disappear against the background of external and internal challenges. To a large extent, the condition of the future in this case depends on what vector the geopolitical processes will have and what Washington’s policy will be after the January inauguration of Donald Trump. In this case, the probability of both negative and positive scenarios is not minimal and at the same time does not belong to the category of something inevitable. As for internal challenges, in the appropriate context, it is worth mentioning the German economy, which clearly lacks growth momentum. This economic system is the largest in the eurozone, which is why its condition is a factor of sensitive impact that is not limited to the borders of one country. So far, there is no answer to the question of when Berlin will be able to cope with the difficulties.
