"The European Central Bank might not have reached its finish line yet"
Rewritten Article:
Hey there! Let's dive into the ECB's recent decision regarding interest rates and whether it was the right call.
In the current economic climate, I'd usually endorse a 50 basis point rate cut due to the weak growth. However, we're not dealing with ordinary times here. Various structural factors are at play, indicating that inflation will persist, despite the economy's sluggish performance. It's tricky to determine right or wrong in this situation. I think the ECB acted prudently, considering its focus on maintaining price stability and the 2% inflation target. However, we might question the appropriateness of these targets in their current form.
Why is the inflation target, 2%, a matter of debate?
The ECB's price stability mandate specifies a medium-term inflation rate of 2%. It could be advantageous to make this range wider, say 1% to 3%. This flexibility would enable the ECB to loosen monetary policy more effectively during this phase, boosting the economy. But I haven't found any credible studies justifying the exact 2% inflation rate.
It seems the ECB hasn't considered adjusting the inflation target for now.
The ECB is planning to review its strategy in 2025. Can we expect a change in the inflation target then?
It would be desirable for the ECB to have more leeway in its monetary policy. Yet, I don't anticipate significant strategic adjustments during the review. The ECB's communication hasn't indicated that changing the inflation target is currently a concern.
By structural factors, I mean...
Demographic shifts lead to labor shortages, causing wage growth, even in the face of two years of no economic growth in Germany, for instance. Climate change is another inflation driver. Additionally, protectionism is on the rise, not only due to Donald Trump's presidency in the US.
Does ECB President Christine Lagarde share your pessimism about inflation?
The ECB believes it's nearing the finish line, but I'm skeptical. Based on the mentioned structural factors, I predict inflation to average 2.6% next year, potentially reaching 3% in 2026.
So, do financial markets overestimate the number of interest rate cuts?
According to my estimation, there should be significantly fewer rate cuts than what the markets anticipate. I expect two 25 basis point interest rate cuts in the first quarter, followed by a prolonged rate pause. The deposit rate would end 2025 at 2.5%, approximately 100 basis points higher than the current market expectations. I also believe an ECB interest rate hike is possible in 2026.
Does this mean a 50 basis point interest rate cut by the ECB in January is off the table?
Although Lagarde expressed confidence that the inflation target will be reached, she remained cautious and repeatedly underscored the ECB's data-dependent nature. Thus, I assume they'll proceed cautiously in January. For the year as a whole, more interest rate hikes might only be realistic if 2025 growth is significantly lower than the ECB's and my projected 1.1%. If growth is 0.5% or lower, for example, further interest rate cuts could be a possibility. This could occur if weak economic growth had such a substantial impact on inflation that it wouldn't surpass the ECB's 2% target despite the structural factors.
The ECB has been discussing the neutral interest rate. What's your take on it?
I haven't researched the neutral interest rate's location in the eurozone. Besides, I don't find it beneficial for guiding short-term monetary policy because it isn't static. When there's a sudden, sustained increase in demand from abroad, for instance, the key interest rate might no longer be neutral. However, the discussion about the neutral interest rate is intriguing as it reveals each council member's dovish or hawkish stance.
Another topic on the table, particularly amid the French political crisis, is the potential use of the TPI instrument. Could it help if France's access to the capital market was threatened?
If such a situation arises, one could argue that France is responsible for its own situation, and the TPI isn't meant for such cases. On the other hand, if there's no apparent culprit, such as France being mired in a political stalemate, the ECB might use TPI to prevent a financial crisis. However, it would be interesting to see how the ECB justifies its use in such a scenario. Nonetheless, I don't expect France to reach this point.
The interview was conducted by Martin Pirkl.
Enrichment Data:
Overall:
Current Stance on Inflation Target
The European Central Bank (ECB) continues to uphold its medium-term inflation target of 2%. The ECB has stated that most indicators of underlying inflation suggest inflation will stabilize around this target in the long run[2][4]. Recent decisions, such as lowering key interest rates by 25 basis points, align with the ECB's objective to ensure inflation remains at this level without explicitly committing to a specific rate path[2][4].
Potential Use of the Transmission Protection Instrument (TPI)
The ECB has emphasized its willingness to utilize all available instruments, including the Transmission Protection Instrument (TPI), to preserve the smooth transmission of monetary policy across the euro area[4]. The TPI is a tool that may be activated to counteract unexpected market dynamics that may jeopardize the consistent transmission of monetary policy throughout the euro area. However, the ECB has not publicly specified scenarios in which the TPI might be employed in response to political crises, but it is prepared to modify its policies as necessary.
Response to Political Crises
While the ECB has not directly connected the usage of TPI to political crises, it has acknowledged mounting uncertainty and challenges from trade tensions and market volatility[2][4]. The ECB's stance is to remain data-dependent and adaptable in its monetary policy decisions, ensuring that it can react to any potential economic or financial developments that may emerge from such crises[2][4].
The European Central Bank (ECB) maintains its 2% inflation target, emphasizing its alignment with this rate in recent decisions such as interest rate reductions. However, Rubia questions the appropriateness of the current target, suggesting a broader range might offer more flexibility for monetary policy adjustments.
Inflation could be driven by various structural factors, including demographic shifts, climate change, and rising protectionism. These factors may contribute to inflation even in sluggish economic conditions, as seen in Germany's two years of no growth.
The ECB has stated its intention to review its strategy in 2025, leaving open the possibility of adjustments to the inflation target. However, the current focus seems to be on maintaining the existing target, with the ECB steering a data-dependent approach.
In response to political crises, the ECB has highlighted its readiness to employ the Transmission Protection Instrument (TPI). While it has not publicly linked TPI usage to political crises, it is prepared to adapt policies as necessary to preserve the smooth transmission of monetary policy.
