ECB to keep rates high despite ease in economy

The European Central Bank (ECB) is poised to convey a resolute message in the upcoming week, asserting that borrowing costs are set to remain high for an extended period, as indicated by a Bloomberg poll of analysts. Respondents in the poll do not anticipate further interest rate hikes and predict that the ECB’s Governing Council will confirm by January that interest rates have reached their peak. Instead, they expect the first interest rate cut to occur in September, following earlier actions to expedite the reduction of the central bank’s balance sheet.

The ECB, led by President Christine Lagarde, has already taken the deposit rate to a record 4% through a series of 10 consecutive increases. Policymakers have conveyed that they will exercise caution to assess whether these measures are sufficient to bring inflation back to the targeted 2%. Recent developments, including a bond market rout and the Israel-Hamas conflict, have heightened economic risks in the 20-nation euro area.

Analysts such as Carsten Brzeski, ING’s head of macro, have noted that developments since the September meeting have worsened the eurozone’s growth outlook, although they have also increased inflationary risks due to surging oil prices. In light of these factors, as well as the rise in bond yields and geopolitical tensions, it appears likely that the ECB will opt for a pause in its policy at the upcoming meeting.

During recent meetings of the International Monetary Fund, ECB President Lagarde emphasised that the central bank cannot declare victory over inflation at this stage. She urged patience and caution, particularly in the face of potential new supply shocks. While there has been a notable slowdown in price increases and some indications that wage pressures may be subsiding, inflation expectations remain elevated. Moreover, the modest recovery observed in the struggling manufacturing sector is being overshadowed by broader economic risks and uncertainties.