ECB will not start cutting interest rates in ‘next couple of quarters’, warns Lagarde

The European Central Bank (ECB) will not begin cutting rates for at least “the next couple of quarters”, its president Christine Lagarde has said.

Ms Lagarde said on Friday that euro zone inflation would come down to its 2 per cent target if interest rates were kept at their current levels for “long enough”. But she added: “It is not something that [means] in the next couple of quarters we will be seeing a change. ‘Long enough’ has to be long enough.”

The ECB last month left its benchmark deposit and lending rates unchanged, ending a series of 10 consecutive increases that has taken the deposit rate from a record low of minus 0.5 per cent last year to a high of 4 per cent in an attempt to tame inflation. Its lending rate stands at 4.5 per cent.

Markets are now pricing in a 75 per cent probability of a rate cut by the ECB by April, up from a 30 per cent chance in early October.

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Ms Lagarde said euro zone inflation could still rebound from its recent two-year low, especially if there is another supply shock from the energy sector.

[ ECB must keep rates at or near 4% until 2024 to get inflation down, warns IMF ]

Inflation in the single currency bloc slowed to 2.9 per cent in October, down from its peak of 10.6 per cent a year earlier. But core inflation, which strips out volatile energy and food prices, remained at 4.2 per cent – more than double the ECB’s target.

“We should not assume this 2.9 per cent respectable headline rate can be taken for granted,” Ms Lagarde said. “Even if energy prices were to remain where they are there will be a resurgence of probably higher numbers going forward and we should be expecting that.”

“Regardless of what the ECB does the next move for mortgage rates in Ireland is probably going to be up,” said Daragh Cassidy of Bonkers.ie. “The main lenders, Bank of Ireland, PTSB and AIB, still have to react to a lot of the previously announced rate increases ... A lot of banks haven’t had to borrow at the higher interest rates yet. The longer these higher interest rates go on the more banks have to start borrowing at 4.5 per cent, and that is eventually going to feed through to higher interest rates.”

Ms Lagarde is trying to pull off a delicate balancing act: keeping borrowing costs at an elevated level for long enough to be sure that price pressures have been tamed, without causing a destabilising recession or a renewed debt crisis in the region.

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The euro zone economy ground to a halt this year. Some economists think it could contract again in the fourth quarter.

Ms Lagarde said: “We are in this fascinating race against time where the calibration of our monetary policy has to be sustainable and subtle at the same time.”

Asked about the financial sustainability of some highly indebted euro zone members, such as Italy – where debt levels have risen above 140 per cent of gross domestic product (GDP) – she said: “Many countries have taken advantage of very low interest rates to extend the maturity of their debt.” Ms Lagarde pointed out that the average debt service cost of euro zone countries was only 1.7 per cent.

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“But it is a fact that there will be refinancings coming up as redemptions come along, and the cost of financing will be increasing,” she added.

She said she was “a little bit reassured” by early signs that the finance ministers of Germany and France had this week moved closer towards agreeing on new fiscal rules for EU countries, which she said was “critically important” to achieve.

The EU’s Stability and Growth Pact, which governs national spending and borrowing and is widely seen as unworkable, has been suspended since the pandemic hit in 2020 but is due to come back into force next year unless a reform is agreed before then. – Copyright The Financial Times Limited 2023