by Francesco Canepa and Balazs Koranyi
FRANKFURT (Reuters) – The European Central Bank (ECB) as expected on Thursday chose to keep its key interest rates at their current level, but pushed back against expectations of an imminent interest rate cut, reaffirming that the costs borrowing would remain at record levels despite the lowering of inflation forecasts.
The ECB deposit rate remains fixed at 4.0%, its highest level since the creation of the euro in 1999, after ten increases since July 2022.
“We have not discussed rate cuts. No discussions, no debate on this issue,” declared the president of the institution, Christine Lagarde, during the traditional press conference following the meeting of the Governing Council .
In its press release, the ECB also did not hint at a possible rate cut, instead emphasizing that inflation would rebound soon and that price pressures remained strong.
“The slowdown in underlying inflation has continued. But tensions on domestic prices remain sustained, mainly due to dynamic growth in unit labor costs,” writes the ECB.
The central bank reiterated that rates will be set “at sufficiently restrictive levels, for as long as necessary.”
“Should we lower our guard? We asked ourselves the question. No, we absolutely must not lower our guard,” declared Christine Lagarde.
While recognizing that inflationary pressures were easing in the euro zone, the President of the ECB estimated that domestic inflation, fueled largely by wage costs, was “not moving”.
“We need to better understand what is happening on this point,” she observed, referring to this wage dynamic and how companies will absorb further wage increases.
INFLATION SEEN AT 2.7% IN 2024
The ECB’s latest announcements thwart investors’ expectations of interest rate cuts during the first half of 2024.
Traders now estimate that the ECB is expected to start cutting rates in April with a total cut of 140 basis points next year, compared to 160 basis points expected before the ECB announcements.
On the financial markets, the European stock markets attenuated their progress while the euro accelerated its progress against the dollar (+1%) and European bond yields attenuated their decline.
The ECB also lowered its inflation forecast for 2024 on Thursday, now forecasting a price increase of 2.7% next year compared to 3.2% in its previous projections three months ago.
Inflation is expected at 2.1% in 2025, then 1.9% in 2026, returning to the central bank’s 2% objective.
Growth prospects in the euro zone remain weak, reflecting estimates that any economic recovery from a weak 2023 will be slow, as consumers have lost part of their real income due to high inflation over the last two years.
The economy of the 20 countries sharing the single currency should record growth of 0.8% next year compared to a forecast of 1.0% provided in September by the ECB. In 2025, growth is still expected at 1.5%.
VOICES FOR QUICK DELETION OF PEPP
Concerning the ECB’s balance sheet, the institution said it wanted to move forward with its normalization, in particular by putting an end to its latest bond buyback program. This Pandemic Emergency Purchase Program (PEPP), a legacy of the COVID-19 pandemic, has reached 1.7 trillion euros and the ECB wants to reduce it by 7.5 billion euros per month. here at the end of 2024.
It said it would only replace maturing bonds through June, then gradually end reinvestments during the second half of the year.
The PEPP was initially scheduled to be sterilized at the end of next year.
“Everyone agrees to stop reinvestments at the end of 2024. Some members would have liked a slightly different ‘tapering’ – starting a little earlier or starting later – so we ended up with this (end 2024),” declared Christine Lagarde.
“This is truly a balance sheet normalization. This is the right time to do it. The markets have absorbed the drop in our APP reinvestments (the ECB’s historic asset purchase program) in a very similar way,” she added.
Christine Lagarde also believes that the institution’s choice of PEPP reinvestments has no impact on its decisions on interest rates.
“It has absolutely nothing to do with, ‘Oh, if they’re doing this with PEPP, then maybe they’re forecasting this on rates,'” she explained.
“No, rates are the main tool, and we will use it regardless of what happens on the PEPP side,” she insisted.
(Written by Claude Chendjou, with Francesco Canepa in Frankfurt, edited by Kate Entringer and Blandine Hénault)
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