European Central Bank Maintains Interest Rates
The European Central Bank (ECB) has decided to keep its key interest rate for refinancing operations at 4.25%, leaving the possibility open for a potential rate reduction before September. Despite concerns about geopolitical uncertainty and the rapid increase in wages that could continue to drive prices up, the ECB has chosen to keep the rates unchanged. The other two key interest rates in the eurozone also remain unchanged – the short-term credit rate at 4.50% and the deposit rate at 3.75%. The decision was made by the bank’s governing council during an official meeting.
The European Central Bank’s Meeting and Market Expectations
On July 18th, a meeting took place that fully met market expectations. However, investors are eagerly looking for clues about future interest rate moves in the statements made by ECB President Christine Lagarde and her colleagues. Most economists believe that the institution will likely make its second interest rate cut of the year on September 12th, following the one in June, if data continues to show that inflation is steadily approaching the target of 2% annually, which it is expected to reach by the end of 2025.
The increase in consumer prices in the eurozone has led to speculation about the ECB’s next steps and how they will impact the economy.
Inflation Rate Drops in June 2022
The inflation rate in June 2022 saw a significant decrease from the double-digit 10.6% in October 2022 to 2.5%. This decline comes after a slight increase from 2.6% in May. However, the core component of the index, which excludes highly volatile food and energy components, remains steady at 2.9% – surpassing experts’ forecasts. Monetary strategists are seriously concerned about the political turmoil, especially following the extraordinary elections in France on July 7, which did not produce a clear winner with an absolute parliamentary majority to form a stable government. The left-wing front, which garnered the most votes, is now facing challenges in forming a coalition government.
Rising Concerns about Inflation in the Eurozone
There are growing concerns that a new government with a high-spending program in the second largest economy in the Eurozone will push inflation up. This has raised worries about a potential future victory of former President Donald Trump in the upcoming November presidential elections in the United States, which could contribute to an inflationary surge in the Old Continent if a trade war ensues. Additionally, the Eurozone is already grappling with a 5% increase in wages, as workers demand compensation for the heaviest inflation in generations.
The Impact of Monetary Policy on Service Sector Inflation
The European Central Bank recently announced that it is keeping a tight monetary policy to control inflation in the service sector, which is heavily influenced by the labor market. Despite this, internal pressures on prices remain strong, with high inflation in the services sector expected to persist above target levels for much of the coming year, according to a statement from the ECB’s Governing Council.
Analysts predict that the institution will wait for more data on labor compensation before making any further decisions on monetary policy.
The Importance of Monetary Discipline in Economic Growth
Before continuing to loosen monetary discipline, it is crucial to consider the impact on inflation, economic growth, and productivity. Monetary strategists have highlighted the inflation outlook, existing inflation dynamics, and the effectiveness of monetary policy in the broader economy as reasons for the interest rate cut in June – the first since 2019. In their official statement following the July 18 meeting, European central bankers noted that they will continue to monitor these areas and that this is not a prelude to specific interest rate actions. However, market participants should remain cautious.
Expectations for ECB Interest Rate Cuts
The latest assessments show solid expectations for two more interest rate cuts by the ECB, each by 25 basis points, by the end of this year – in September and December, with an interest rate pause at the ECB meeting in October. In their official statement, ECB monetary strategists also provide information on the process of absorbing the inflated bank balance sheets resulting from the adopted programs to support the eurozone economy.
The Asset Purchase Program (APP) portfolio is decreasing in value at a measured and predictable pace because the Eurosystem is no longer investing in it.
European Central Bank Announces Changes in Asset Purchase Programs
The European Central Bank has announced that it will not reinvest any principal payments from maturing securities purchased under the Pandemic Emergency Purchase Program (PEPP). This decision will reduce the program’s portfolio by an average of 7.5 billion euros per month. The ECB’s Governing Council intends to cease all reinvestments under the PEPP by the end of 2024.
In terms of refinancing operations, banks will be required to repay the amounts borrowed under the long-term financing operations. This move is part of the ECB’s strategy to gradually unwind the extraordinary measures implemented in response to the pandemic.
The ECB’s assessment of targeted credit transactions
The Governing Council will regularly evaluate the contribution of targeted credit transactions and their repayment to the position of the ECB’s monetary policy.
