"ECB may still face challenges ahead"
In a casual chat, let's talk about the European Central Bank (ECB) and their recent monetary policy decisions. Some folks thought the ECB should've slashed interest rates by 50 basis points on December 12. But was it the right call for the central bank to hold off?
I'd agree with a rate cut in normal times, given the weak economic growth, 'cause that sorta means less inflationary pressure. But these ain't normal times. There are structural factors at play, leading me to think that inflation will remain high despite the economy's poor performance. So, it's not so black and white, right or wrong. I'd say the ECB made a clever move, sticking to its clear price stability mandate and 2% inflation target. Whether these targets are ideal in their current form, that's another story.
What's the beef with the inflation target, anyway?
The ECB defines its price stability mandate with a medium-term inflation rate of 2%. It'd be wise to make this more flexible, maybe with a range of 1% to 3%. That'd let the ECB ease more in the current phase, which'd be key for the economy. But here's the kicker—I haven't seen any study explaining why inflation must be precisely 2%. The ECB's comms don't seem to indicate that changing the inflation target is high on the agenda right now.
In 2025, the ECB's strategy will get a once-over. You think there'll be any adjustments to the inflation target then?
I reckon the ECB would benefit from more flexibility in its monetary policy, but I ain't holding my breath for significant changes during the strategy review. The ECB's comms don't future-predict a change in attitude toward the inflation target.
So, what are these structural factors that'll keep inflation high, anyways?
Demographic changes and labor shortages are leading to high wage growth, even with two years of lousy economic growth in Germany, for instance. Climate change and increasing protectionism will also jack up inflation. Some folks might be surprised, but even after Donald Trump got elected, we're still seeing protectionist policies.
ECB President Christine Lagarde seems pretty confident that inflation will stabilize at 2% in 2025. You seem less convinced, huh?
The ECB believes it's nearing the finish line, but I ain't sold on it. Based on these structural factors, I expect inflation to average 2.6% next year, potentially rising to 3% in 2026.
I reckon two 25 basis point interest rate cuts in the first quarter, followed by a longer rate pause. That means there should be fewer rate cuts than financial markets are expecting, right?
I'm predicting two 25 basis point interest rate cuts in the first quarter, followed by a lengthy rate freeze. The deposit rate would be around 2.5% at the end of 2025, about 100 basis points higher than what's priced in on financial markets. I also believe an ECB interest rate hike is possible in 2026.
So, you think a 50 basis point interest rate cut by the ECB in January, like some investors are speculating, is a no-go?
Although Lagarde seemed optimistic at the meeting, she was careful and kept reminding us that the ECB stays data-driven. I reckon they'll stay cautious in January. For the year as a whole, more rate hikes are only realistic if growth in 2025 is significantly lower than the 1.1% expected by the ECB and us, like 0.5% or less. If growth is that bad, I believe rate cuts are still in the cards. Weak economic growth would then have such a significant impact on inflation that it wouldn't exceed the ECB's target of 2%, despite the structural factors.
The ECB's been talking about the neutral interest rate recently. What's your take?
I haven't researched the neutral interest rate for the eurozone, and I'm not sure it's all that helpful in guiding short-term monetary policy. If the neutral interest rate is even remotely useful, it's not static, so it can have a neutral effect one moment, then a major, sustained surge in demand from abroad might make it lose its neutral effect. But the debate about the neutral interest rate is fascinating because it shows how to-the-point someone is based on their estimates of individual Council members.
I see no reason for the ECB to use TPI, a tool that'd let 'em buy French government bonds and keep spreads from ballooning.
These days, folks are chatting about the possible use of TPI, especially since there's a political crisis in France. TPI could help prevent spreads from widening between French and German government bonds. So, if France's access to the capital market was threatened by a political crisis, could the ECB justify using TPI to bail 'em out?
This is an intriguing question. On one hand, if such a situation popped up, one could argue that France is responsible for its own mess, and TPI isn't designed for these types of scenarios. On the other hand, there might not be a specific culprit, as the whole strange situation seems to have sprung from a standoff within France. If the ECB perceives France's access to the capital market as threatened, I suspect they'd whip out TPI to prevent a financial crisis. It'd be interesting to see how the ECB justifies using TPI, but as I mentioned, I don't foresee France reaching that dire point.
The interview was conducted by Martin Pirkl.
Bonus Info:The ECB maintains its medium-term inflation target at 2%, with no plans to adjust it during the upcoming strategy review. The bank's focus is on achieving this target through data-driven monetary policy decisions. While discussions around TPI are happening, there's no indication that the ECB plans to use it. The review in 2025 may involve refining the monetary policy toolkit and communication strategies rather than altering core targets like inflation.
The ECB's focus on maintaining a medium-term inflation target of 2%, as mentioned by Martin Pirkl, might be a topic of debate in the arena of general-news, politics, and business discussions. It's worth considering the possibility of making this target more flexible, perhaps with a range of 1% to 3%, to better address the current economic climate and future challenges, such as those posed by demographic changes, labor shortages, climate change, and increasing protectionism. However, as Pirkl highlights, there's no indication that the ECB plans to adjust its inflation target during the strategy review in 2025. The central bank instead aims to refine its monetary policy toolkit and communication strategies, while keeping an eye on structural factors that could maintain high inflation rates.
