Inflation in the euro zone may not be decelerating as rapidly as it did last year, but that shouldn’t deter the European Central Bank from following the Swiss National Bank’s lead in cutting rates. With Tuesday’s numbers showing German consumer prices increased by just 2.3 percent last month and Wednesday’s figures for the bloc showing a bigger-than-expected slowdown to 2.4 percent from February’s 2.6 percent pace, the evidence is compelling that inflation is beaten; unfortunately, so is the economy.
That’s why policymakers who’ve made it plain they’re minded to cut borrowing costs in June should be emboldened to strike earlier, by introducing their first 25 basis-point reduction in official interest rates at next week’s Thursday meeting. There’s a particularly long gap of 39 business days between April 11 and the June 6 meeting; staying on hold next week could mean an agonizing wait as worsening economic data keep trundling in.
March’s core inflation measure declined to 2.9 percent from 3.1 percent in February. Services inflation in the euro zone, as is the case elsewhere, is proving sticky; it was slower to rise, so unsurprisingly it’s also last to fall back and came in at 4 percent for last month.
Bank of France President Francois Villeroy de Galhau, often the bellwether for ECB policy changes, has been the most vocal policymaker about potentially cutting as soon as next Thursday. In a speech last week, he stressed that the potential for a further slowdown in growth means that “the time has come to take out an insurance against this second risk by beginning rate cuts.”
Among the biggest euro zone economies, it’s clear that after some stickiness in January and February the downward trend in inflation is resuming. German state inflation was lower across the board. French inflation slowed to 2.4 percent in March from 3.2 percent in the prior month. Italian CPI rose to 1.3 percent from 0.8 percent, but this gain was less than expected and remains significantly below the ECB’s overall target. Spain is an outlier, with March CPI ticking up to 3.2 percent from 2.9 percent, but this is partly down to a reversal of energy-tax cuts.
Even the most hawkish member of the governing council, Austrian central bank head Robert Holzmann, is seeing the light, saying in a Saturday newspaper interview that “the European economy is growing at a slower pace than the US. That could mean that our price dynamic weakens more.”
Holzmann warned that cutting ECB rates before the Federal Reserve moves comes with risks. It does — especially for the value of the euro — but it’s not a danger the Governing Council will lessen by delaying, as Europe has bigger economic problems than the US. Whether the Fed cuts in June is now a toss-up, based on expectations in the futures market, after a surprisingly strong Institute for Supply Management release for March.
The ECB expects CPI to fall to 2.2 percent by August, but it could be that low as soon as this month. Bloomberg Economics estimates inflation will slow to 1.8 percent this summer, dropping to 1.4 percent in early 2025. And importantly, forward inflation forecasts out to 2026 are stable, with the five-year inflation swap at 2.3 percent.
Euro-zone wage growth is forecast to have dipped to a 4 percent annual pace in the first quarter, from 4.6 percent in the final three months of 2023, and to fall further to 3.5 percent by the summer. Less pressure from pay settlements is one of the three main criteria that President Christine Lagarde cited at the last meeting, along with profit margins and productivity growth. Executive board member Piero Cipollone, in his first major policy speech in Brussels last Wednesday, called for the ECB to cut rates even if wage levels remain robust, to underpin growth.
Official interest rates are the highest in the euro’s quarter-century existence, and simply maintaining them at current levels rates adds to monetary tightening. Inflation is already around 150 basis points below the 4 percent deposit rate, creating positive real rates. But the central bank is also draining liquidity; both of its quantitative easing programs are shrinking, and the rundown of its generous long-term funding operations saw banks hand back €250 billion ($270 billion) last week. That leaves around €140 billion maturing by the end of the year. The screws are being tightened across the system.
Bloomberg Economics looks for 100 basis points of easing in total this year; a series of ECB reductions over the last quarter looks likely if weakening pay and inflation forecasts bear out.
Even the cautious Swiss National Bank cut rates on March 21, showing it had the confidence to move ahead of both its bigger neighbor and the US central bank. It knows the ECB has to lower rates soon enough.
Financial conditions will remain tight in the euro zone even after several rate cuts. March monetary data saw a modest improvement, but from very weak levels. The credit impulse of lending to households and corporates is at negative 3.6 percent — lower than the minus 3.1 percent trough experienced during the euro crisis. As recently as mid-2022 it was growing at more than 3 percent, so it's little wonder that the euro economy has struggled to grow at all. The risks of something serious breaking — like a commercial real estate crisis — remain ever-present, while pressure on consumer demand is crushing.
Euro broad money measures have stabilised, but the narrow M1 gauge is contracting by 7.7 percent annually. Credit growth to individuals is minus 0.3 percent. The ECB’s mandate to keep inflation at or near 2 percent, but it also is responsible for maintaining financial stability; if inflation falls well below 2 percent, policymakers will be headed back into the fix they wrested with for a decade.
Recession would unnecessarily disrupt the entire European Union, and there’s still a chance one can be avoided. Getting a handle on runaway prices was never going to be easy, but the bigger risk now is overdoing the medicine. Waiting for inflation perfection will just guarantee a downturn that could turn into deflation. It’s time to act.
Marcus Ashworth is a Bloomberg Opinion columnist covering European markets. Views are personal and do not represent the stand of this publication.
Credit: Bloomberg
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