The upcoming changes in interest rates
In the coming weeks, the European Central Bank (ECB) is anticipated to decrease interest rates. This decision is influenced by declining inflation and a struggling economy. However, the ECB must tread carefully due to potential risks.
According to recent reports, it's probable the ECB will implement this change during their upcoming meeting on Thursday. This comes after several of its top officials have openly expressed their support for lower interest rates. Chief Economist Philip Lane confirmed their intentions, stating, "If there are no major surprises, what we see is sufficient to lift the highest level [of restrictive monetary policy]."
Several months ago, with the escalation of the Russian-Ukraine conflict, inflation in the euro area jumped significantly and reached substantial highs. The ECB had to abandon their long-held zero-interest-rate policy and raise interest rates rapidly. The interest rate at which banks can borrow funds from the central bank reached 4.5%, while the deposit interest rate, which banks receive for parked funds, is set at 4% in the common currency area.
Furthermore, inflation has experienced a considerable drop. It's currently at 2.4%, hovering close to the target of 2% that the ECB aims for. The central bank expects to achieve this target by the summer of the following year.
There are several factors contributing to the likelihood of a rate reduction. One of them is the faltering economy in the eurozone. Most forecasts suggest the ECB will lower the benchmark rates by 0.25 percentage points. A more significant adjustment is considered unlikely.
Additionally, two aspects that may prompt the ECB to approach this matter cautiously are the wage development in the eurozone and the Federal Reserve's interest rate policy in the United States.
Wage growth, a key driver of inflation in the 20-country bloc, reached a peak earlier this year. However, the trend suggests a slowdown, as analyzed by the ECB. This is an essential consideration.
Wages increased by 4.69% in the 20-country bloc during the first quarter, followed by a 4.45% increase in the last quarter of 2022. The eurozone's governing body believes wage growth of around 3% aligns with their medium-term inflation target of 2% price growth. Any exceedance of that target suggests inflationary pressure within the economy, potentially leading to rising prices.
Moreover, the Fed is delaying the previously announced interest rate cuts due to the persistence of higher-than-expected inflation in the United States. The current US interest rate is between 5.25% and 5.5%, which is higher than in the eurozone. The larger the ECB's rate reduction, the larger the discrepancy between the two currencies, making the euro less attractive to investors due to the lower interest rates. This could negatively impact the euro, as the US dollar becomes more enticing.
Lane, when asked about these concerns, expressed confidence. He noted, "There has been very little movement" in this direction recently. The euro has seen a substantial recovery since reaching its six-month low in April.
Lane did not provide a definite timeline for future rate reductions, remarking, "It will be bumpy and it will go step by step." He emphasized that the ECB will be "restrictive throughout the year." Restrictive interest rates are those at which economic growth is slowed down. "But within this restrictive zone, we can move a little bit down."
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Source: www.ntv.de
