Another ECB rate cut in July would be inappropriate
The European Central Bank (ECB) isn't giving any clear signals about whether a second rate cut will follow next month. ECB President Christine Lagarde has avoided committing to a specific course, and reiterated her mantra that decisions would be made on a data-dependent basis from meeting to meeting. However, there is decreasing support for a second rate cut in July.
This hesitation stems not only from the ECB's less optimistic outlook on inflation for this year. It has raised its forecasts for both the overall inflation rate and core inflation, which serves as a gauge for underlying price pressures. Recent economic data has also been complicated Wage growth is strong, and it is far from certain whether it will slow down over the year as the ECB predicts. Inflation in May was higher than expected. Although one-off effects contributed to this, it still indicates that the disinflation process will be bumpy, something that the ECB acknowledges.
ECB not under time pressure
Moreover, there is little pressure on the ECB to hurry the rate reversal processl. The eurozone economy is recovering slowly. Economic growth is expected to pick up further in the second half of the year, although at a relatively low level. Accordingly, the ECB's new forecast anticipates more growth this year. A better-performing economy tends to increase price pressures. The ECB also need not fear that its restrictive monetary policy will push the eurozone economy into a recession. The current interest rate level is not leading to a significant rise in unemployment, a credit crunch, or even a threat to financial stability.
The ECB has time to wait until it can be more confident that inflation will fall to the target level in 2025. A rate cut in July would be premature and could lead to a scenario where the ECB might have to raise rates again, which would be a nightmare scenario considering the economic impact. This is something the central bank wants to avoid at all costs.
Was the recent rate cut a mistake given the bumpy inflation reduction fugures? No, because the path to the inflation target does not look too long now. Monetary policy remains clearly restrictive. In fact, real interest rates are currently higher than at the time of the last rate hike. Gradually and cautiously reducing the restrictive policies is therefore the right approach.
