ECB – four arguments against a rate cut on Thursday

Until recently, economists assumed that the ECB would cut its policy rates next only in December when it publishes its new forecasts for inflation and the economy. However, investors are now firmly expecting the ECB to lower rates already at Thursday's meeting just five weeks after the last rate cut in mid-September.

At first glance, there are good reasons for a faster rate cut pace. After all, the Purchasing Managers' Index, an important leading economic indicator for the eurozone, has slipped close to recession territory. In addition, core inflation, i.e. the rate of inflation excluding the volatile prices for energy and food, has also fallen recently. Nevertheless, a faster pace of rate cuts would be risky.

Firstly, core inflation has fallen partly because the fall in energy prices has had a knock-on effect on core consumer prices via transport services, for example, indirectly lowering them. This is what we saw last autumn. However, this effect fizzled out shortly after the turn of the year and the sharp rise in wages caused core inflation to rise again.
Secondly, the rise in collectively agreed wages in the eurozone has accelerated further in the meantime and levelled off at a high 4.5 per cent, which is not compatible with the ECB's inflation target of 2%. Contrary to the ECB's claims, the rise in wages has not yet slowed.
Thirdly, many companies in the eurozone are still suffering from a shortage of labour. Around a fifth of companies feel that this is hampering their business – much more than the average of the past twenty years. If the ECB lowers interest rates in this situation, it will fuel companies' demand for investment and exacerbate labour market shortages in the medium term. This is likely to increase the bargaining power of employees again, which would lead to high wage settlements and inflation rates.
Fourthly, caution is generally advisable after phases of high inflation. Companies and citizens will remember the inflation shock for a long time to come; long-term inflation expectations are no longer as firmly anchored at 2% as they were in the years before coronavirus. The ECB should therefore stick to a restrictive monetary policy for longer than usual. Otherwise, the fight against inflation risks failing again, as it did after the oil price shocks of the 1970s, because the central bank eases its policy too early.

All in all, it would be risky if the ECB were to cut interest rates again on Thursday and increase the pace of interest rate cuts.

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