The European Central Bank is keeping interest rates stable, citing wage growth
The European Central Bank kept interest rates stable for the fourth time in a row on Thursday, even as policymakers noted the progress made in their fight against high inflation.
Deposit rates remained at 4 percent, the highest level in the central bank’s two-and-a-half-year history. Officials wonder how quickly they can cut interest rates.
“Interest rates are at a level that, if maintained for a sufficiently long period, will make a substantial contribution,” the central bank said in a statement. “The Governing Council’s future decisions will ensure that the policy rate will be set at sufficiently restrictive levels for as long as necessary.”
Last month, annual inflation in the euro zone slowed to 2.6 percent, moving closer to the central bank’s target. But policymakers at the bank, which sets interest rates for the 20 countries that use the euro, have been cautious about cutting rates too quickly and reviving inflationary pressures. Economists have warned that the path to reaching the bank’s inflation target is likely to be bumpy.
These concerns were reflected in the latest inflation report, where nominal interest rates for February came in higher than economists expected and core inflation, a critical gauge of domestic price pressures that excludes energy and food prices, was also higher than forecast.
Traders had been betting that interest rates would be cut in June, but began to temper their expectations after the inflation data was released. These interest rate cut expectations are likely to be reinforced again as the central bank lowered its inflation expectations on Thursday. Inflation now averages 2 percent, reaching the target next year, before falling to 1.9 percent in 2026.
Other major central banks face a similar challenge. Western countries have made progress in curbing inflation. But there are still concerns that inflationary pressures have not completely disappeared, especially as lower inflation increases consumers’ purchasing power. Interest rates on government debt have also fallen, easing financial conditions for businesses and homeowners. These factors may lead central bankers to respond by keeping policy rates high for longer.
In the United States, Federal Reserve Chairman Jerome H. Powell told lawmakers this week that the bank expected to cut rates this year but still wanted to gain “more confidence” that inflation had been overcome before taking action undertaken. Huw Pill, the Bank of England’s chief economist, said last week that the British central bank should “guard against a false sense of security about inflation developments.”
In recent weeks, ECB policymakers have said they should wait for additional data to gain more confidence that inflation is under control. In particular, they wait until companies and employers make annual salary adjustments, which in Europe often happens at the beginning of the year. Officials are looking for signs that wage increases are slowing, or that companies are absorbing the costs of higher wages rather than passing them on to customers in the form of higher prices.
“While most measures of underlying inflation have eased further, domestic price pressures remain high, partly due to strong wage growth,” the central bank said.
But pressure is mounting to cut interest rates to help Europe’s weak economy, which has been hampered by higher interest rates. The euro zone grew by just 0.5 percent in 2023 and the central bank predicts growth will be just 0.6 percent this year, lowering its expectations from three months ago.
Even once the central bank decides to cut rates, there will be more division over how quickly and how much to cut rates. While the economy may no longer need restrictive monetary policy, it is unlikely that policymakers will want to return to the ‘easy money’ attitude of the past decade, which was intended to prevent deflation.