The governing council of the European Central Bank (ECB) meets this week amid clear indications that inflationary pressures are easing. The latest euro zone inflation data shows a fall in the annual rate to an estimated 2.4 per cent, heading towards the ECB’s 2 per cent target level. The case to start cutting interest rates from their current high levels is building fast.
All the indications are that the ECB will not reduce its key lending rates this week, indicating that it wants to wait for key wage bargaining data due in May to confirm that inflationary pressures are definitely on the wane. In reality, this looks more like a compromise to cover divergent views on the governing council. Most analysts expect that the first reduction will come, instead, at its next policy-setting meeting in June.
The ECB risks moving too slowly, particularly given the emerging weakness in the big euro zone economies, and notably in Germany. The difficulty for the ECB is that it takes time for interest rate changes to have an impact and so the full economic consequences of the sharp rise in interest rates is not yet clear. But the risks have changed – inflation now looks to be under control.
The ECB can cut interest rates significantly from current levels while still keeping downward pressure on inflation. Calls are thus likely to grow on the governing council to justify holding interest rates at record highs for much longer, given the costs this imposes on personal and business borrowers and the impact on sluggish economic growth.
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Given that it looks likely to leave interest rates where they are this week, there is a strong case for the ECB to signal clearly after its meeting the strong likelihood of a cut in June.
It remains unclear, following the first move, how quickly interest rates will then fall. But there is likely to be a series of reductions this year and into 2025, offering significant relief to tracker mortgage holders and leading in time to a general fall in costs to borrowers. Once the interest rates decline starts, it could quickly gather pace.