The European Central Bank cut interest rates for the third time this year on Thursday, pointing out that inflation in the euro zone is now increasingly under control and the economic outlook has worsened.
The first back-to-back rate cut in 13 years marks a shift in focus for the euro zone’s central bank from bringing down inflation to protecting economic growth, which has lagged far behind that of the United States for two years straight.
“The incoming information on inflation shows that the disinflationary process is well on track,” the ECB said. “The inflation outlook is also affected by recent downside surprises in indicators of economic activity.”
The latest economic data is likely to have tilted the balance within the ECB in favour of a rate cut, with business activity and sentiment surveys as well as the inflation reading for September all coming in slightly lower than expected.
The quarter-point cut lowers the rate that the ECB pays on banks’ deposits to 3.25 per cent. Money markets are almost fully pricing in three further reductions through next March.
The ECB did not provide any indication about future moves in its statement, instead repeating its mantra that decisions will be made “meeting by meeting” based on incoming data.
“The Governing Council…will keep policy rates sufficiently restrictive for as long as necessary,” the ECB said.
The euro edged up after the decision which had been well flagged by a number of ECB speakers including President Christine Lagarde.
The ECB can finally claim it has all but tamed the worst bout of inflation in at least a generation.
Prices grew by just 1.7 per cent last month, falling below the bank’s 2 per cent target for the first time in three years. While inflation may edge above 2 per cent by the end of this year, it is expected to hover around that level for the foreseeable future.
The ECB noted pay hikes are still supporting “domestic inflation” — that is growth in the price of services and goods that don’t rely much on imports — but this too was waning.
“Domestic inflation remains high, as wages are still rising at an elevated pace,” it said. “At the same time, labour cost pressures are set to continue easing gradually, with profits partially buffering their impact on inflation.”
Yet the economy has had to pay a high price for that.
High interest rates have sapped investment and economic growth, which has been weak for nearly two years. The most recent data, including about industrial output and bank lending, is pointing to more of the same in the coming months.
An exceptionally resilient labour market is also now starting to show some cracks, with the vacancy rate – or the proportion of vacant jobs as a share of the total – falling from record highs.
This has fuelled calls inside the ECB to ease policy before it is too late.
“Now we face a new risk: undershooting target inflation, which could stifle economic growth,” Portuguese central banker Mario Centeno said recently. “Fewer jobs and reduced investment would add to the sacrifice ratio already endured.”
Some of that weakness is due to structural problems, such as the high energy costs and low competitiveness hobbling Europe’s industrial powerhouse, Germany.
These issues cannot be fixed through lower interest rates alone although they can help at the margin by making capital cheaper.
“We cannot ignore the headwinds to growth,” ECB board member Isabel Schnabel said. “At the same time, monetary policy cannot resolve structural issues.”
Sourse: breakingnews.ie
