The European Central Bank has signalled it still has “work to be done” to tame price pressures after leaving interest rates unchanged, even as it cut its inflation forecasts for this year and 2024.
ECB president Christine Lagarde pushed back against market expectations for it to cut rates as early as March, saying “we should absolutely not lower our guard” against inflationary pressures.
The central bank’s decision on Thursday came as investors ramped up their bets that major central banks are getting closer to lowering borrowing costs, following signals from US Federal Reserve officials that they expect to cut rates more aggressively than previously planned next year.
After the ECB maintained its benchmark deposit rate at its highest-ever level of 4 per cent for the second consecutive meeting, policymakers repeated their determination to keep borrowing costs at “sufficiently restrictive levels for as long as necessary”.
The central bank forecast consumer price growth would slow to its 2 per cent target within the next three years – clearing a key hurdle for them to consider cutting rates. But Lagarde said policymakers would be “a little bit more severe” and aim to hit that milestone by 2025.
The ECB said it expected headline inflation to average 5.4 per cent in 2023, 2.7 per cent in 2024, 2.1 per cent in 2025 and 1.9 per cent in 2026, a “downward revision” for 2023 and 2024 from September’s projections.
The ECB also announced a change to its remaining bond-buying programme, bowing to calls from hawkish members of its governing council to stop purchases earlier than planned.
The central bank would reduce the reinvestments of maturing securities in the €1.7 trillion portfolio it started buying in response to the coronavirus pandemic from the second half of next year, instead of continuing them until the end of 2024. The reinvestments would be cut by €7.5 billion a month from July before ending completely at the end of next year.
The euro reached a two-week high after the ECB decision, trading 0.9 per cent higher against the dollar at $1.0971.
Carsten Brzeski, an economist at ING, said the ECB had offered only “a very small shift towards dovishness” by ditching its previous observation that euro zone inflation was expected to remain “too high for too long”.
German government bond yields – a benchmark for the euro zone – nudged higher straight after Thursday’s meeting to 2.53 per cent but remained 0.12 percentage points lower on the day.
Swaps markets continue to price in six quarter-point ECB rate cuts next year.
Lagarde, who told reporters she was recovering from Covid-19 but was no longer infectious, said the governing council “did not discuss rate cuts at all”, adding that “between hike and cut there is a whole plateau, a whole beach of hold”.
Inflation in the 20-country single currency bloc slowed to an annual rate of 2.4 per cent in November, its lowest level for more than two years, fuelling market bets that the ECB will begin cutting borrowing costs as early as next March.
Economists have been cutting their euro zone growth forecasts after weak recent data and signs that governments will reduce spending – all of which is likely to cool price pressures.
Reflecting the bloc’s weaker outlook, the ECB trimmed its growth forecasts for this year from 0.7 per cent to 0.6 per cent and for next year from 1 per cent to 0.8 per cent. It left its 2025 growth forecast at 1.5 per cent and predicted a similar outcome for 2026.
“The risks to growth remain tilted to the downside,” said Lagarde.
After bond markets rallied in response to the Fed’s announcement late on Wednesday, traders in swaps markets were pricing in at least six quarter-point rate cuts for both the Fed and the ECB next year and five such moves by the Bank of England.
Frederik Ducrozet, head of macroeconomic research at Pictet Wealth Management, said: “If the Fed does cut earlier and faster, it’s going to be very difficult for the ECB to hold on to their position.”
The BoE earlier kept its bank rate unchanged at 5.25 per cent, warning that “key indicators of UK inflation remain elevated”, leaving the option open to raise rates further and saying its policy “is likely to need to be restrictive for an extended period of time”.
This followed a signal from the Swiss central bank that it was nearing a potential rate cut by dropping its insistence that a further tightening of policy “may become necessary”. However, Norway’s central bank bucked the dovish trend by announcing a quarter-percentage point rate rise. – Copyright The Financial Times Limited 2023
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