The European Central Bank's (ECB) plan to maintain high interest rates for an extended period is facing skepticism from economists, who believe it may start to unravel sooner than expected. In a recent survey, a slim majority of economists predicted a final hike in the deposit rate to 4% in September before rate cuts begin in March. However, projections for borrowing costs by the end of 2024 vary widely, ranging from 2% to 4%.
The uncertainty surrounding the timing of inflation returning to the ECB's target of 2% is the main challenge in predicting future rate moves. With inflation currently at 5.5% and reaching over 10% last fall, economists are cautious about the impact of the unprecedented 400 basis points of tightening implemented since July 2021.
There is a delicate balance for the ECB to strike between stopping rate hikes in the near future and maintaining a credible tightening bias. A pause in rate hikes could be misinterpreted by markets as a signal that rate cuts are imminent. ECB President Christine Lagarde will likely emphasize the need for rates to remain restrictive for a longer period when she speaks following the policy announcement on July 27.
Inflation is still seen as the biggest risk to the economy, with policy spillovers from elsewhere also a concern. The Federal Reserve is expected to deliver its final rate hike next week, while market expectations suggest a possible rate cut in the US as early as spring. Despite these challenges, economists have confidence in the ECB's ability to strike the right balance between curbing inflation and supporting the economy.
However, there are differing opinions among the ECB's Governing Council members, making consensus harder to achieve. Finding the correct tone in communicating their intentions to the public is seen as the biggest challenge for ECB officials.
While next week's rate hike seems certain, the question remains whether the ECB will pre-commit to another hike at its next meeting. Market pricing for October will largely depend on this decision. Some experts believe that President Lagarde will not provide any hints about the outcome of the September meeting, emphasizing the ECB's data-dependency and waiting for the September projections.
The ECB raised its inflation forecasts through 2025 but highlighted the highly uncertain outlook last month. With a growing divergence of views within the Governing Council, reaching a compromise on future rate moves will be challenging. Officials are aware of the importance of striking the right balance in their messaging, with silence potentially being the best approach in this regard.
Overall, economists remain cautious about the ECB's plan to maintain high interest rates for an extended period. The path ahead is clouded by stubborn price pressures, a struggling euro-zone economy, and the uncertain impact of previous tightening measures. The ECB will need to carefully navigate these challenges while ensuring its actions align with its goal of taming inflation without causing harm to the economy.