The Brief – Inflated debate: Why won’t the ECB cut rates?

“No one,” Plato’s Socrates once famously declared, “who either knows or believes that there is another course of action, better than the one he is following, will ever continue on his present course.”

For many economists, the European Central Bank’s (ECB) policy meeting later this week will likely provide one of the most convincing refutations yet of the ancient Greek philosopher’s claim.

The Governing Council, the ECB’s main decision-making body, is almost certain to leave its key interest rate at its current record-high level of 4% on Thursday (7 March): its fourth consecutive rate pause, after hiking rates ten times in a row between July 2022 and September 2023.

This bank’s widely anticipated decision comes in spite of the fact that many — and perhaps even the majority of — economists believe that current eurozone data strongly indicates the ECB should begin cutting rates as soon as possible.

If you think the rate debate is for macroeconomy buffs only, think again: Rate decisions, which essentially set the price of borrowing money, filter down to commercial banks, businesses and, ultimately, citizens.

Rate-cutters point to the fact that, at 2.6%, eurozone inflation has already fallen to within a few decimal points of the ECB’s 2% target. 

They also note that inflation is well below the 10.6% peak reached in October 2022, after Russia’s full-scale invasion of Ukraine eight months earlier sent prices soaring across Europe and triggered the ECB’s unprecedented series of rate increases.

Moreover, Europe’s economy is stagnating and “could use a bit of a momentum injection from lower interest rates”, Sander Tordoir, a senior economist at the Centre for European Reform (CER), told Euractiv.

“The rate decision matters because the eurozone economy has come to a long standstill after getting its recovery [from the pandemic] knocked off course by Russia’s war on Ukraine,” he added.

Philipp Lausberg, an analyst at the European Policy Centre, emphasised that rapid rate cuts are also crucial to help finance the EU’s green and digital transitions.

“Investment is key for our transitions that we’re going through,” Lausberg told Euractiv. “And if we really want to make more room for investment, one important step is to decrease the ECB’s interest rate.”

Trade unions’ criticisms of the ECB’s tight monetary policy are, if anything, even more vociferous. 

“We are obviously extremely disappointed that the ECB is going to keep the rates very high,” said Patricia Velicu, a senior policy adviser at industriALL Europe, which represents seven million employees in Europe’s manufacturing, energy, and mining sectors.

“In our opinion, this is bad for everybody. It’s not bad only for workers, it’s also bad for companies. [And] it’s bad for governments because it limits their capacity to invest,” she added.

All of this raises the question: Why is the ECB committed to keeping rates unchanged? 

The answer, unsurprisingly, depends on whom you ask. 

Velicu argues it is because the Governing Council is dominated by “ideologically driven” monetary hawks. 

Lausberg, on the other hand, says the ECB is simply faithfully fulfilling its primary mandate of ensuring that inflation stays at 2% “over the medium term” — weak growth and underinvestment be damned. 

Tordoir, meanwhile, suggests that the argument about rate cuts is largely being conducted in good faith, amid genuine concerns about price pressures resurfacing in the future.

 “There is a strong debate and arguments on the other [non-rate-cutting] side that inflation may prove more sticky,” he said. “There is this fear of self-perpetuation through expectations, and thus it’s better to stamp out the fire completely before loosening monetary policy.”

Tordoir’s remarks were echoed by ING economist Carsten Brzeski, who is also in favour of a rate cut on Thursday but grants that the bank’s concerns about inflation resurfacing are legitimate. 

“The ECB cannot take a chance on inflation developments,” he told Euractiv. “They want and need to be sure that inflation is back on track.”

Such concerns are arguably reminiscent of a remark in another Plato dialogue, where one of Socrates’ interlocutors notes “the misfortune of too much haste, which is too little speed”. 

Translated into contemporary monetary theory: By cutting rates too soon, the fight against inflation may end up taking a lot longer than we’d like.

The Roundup

The EU Council and the European Parliament agreed on Tuesday evening on a revision of the bloc’s plant health law, simplifying rules and setting up an EU task force to combat new pests.

France is preparing to regain its and Europe’s food sovereignty, Agriculture Minister Marc Fesneau told Parliament’s National Defence Committee on Tuesday, stressing that food has become “a weapon” and the EU must “overcome its naivety”

Pro-electric vehicle organisations are calling for data sharing between car manufacturers, electricity grid operators, electric vehicle charge point operators and consumers to facilitate wider adoption of electric vehicles, but concerns over data privacy and protection remain.

Conservative Prime Minister Ulf Kristersson will not be able to serve a second term unless the far-right Sweden Democrats party is in government after the next election – which is a likely scenario based on the upcoming EU election projections – Sweden Democrats leader Jimmie Åkesson said on Tuesday.

The EU border agency Frontex is drawing up ‘potential scenarios’ to assess how it might provide additional support, if needed, at the borders with the Gaza Strip, its executive director, Hans Leijtens, told a group of media, including Euractiv.

Incumbent US President Joe Biden and former president Donald Trump swept to victory in statewide nominating contests across the country on Tuesday, setting up a historic rematch in November’s election.

A balance of power shift after the European Parliament elections will give the centre-right European People’s Party (EPP) the upper hand, allowing them to bend the left while also reaching out to the right in a delicate balancing act that has the potential to backfire.

For the latest health-related news from across Europe, check out this week’s Health Brief.

Look out for…

• Enlargement and Neighbourhood Commissioner Olivér Várhelyi receives representatives of EU agricultural producers on Thursday.
• Competitiveness Council (Internal market and industry) on Thursday.
• EPP congress in Budapest on Wednesday-Thursday.

Views are the author’s

[Edited by Zoran Radosavljevic/Rajnish Singh]