ECB to hold rates again, awaiting clearer signs on inflation

The European Central Bank is expected to freeze interest rates again this week, with officials wary of starting to cut before they see more evidence that recent falls in inflation will be sustained.

After the ECB launched an unprecedented campaign of monetary tightening to tame runaway consumer prices, eurozone inflation has been slowing steadily from a peak of over 10 percent in late 2022.

It eased to 2.6 percent in February, according to preliminary figure, down from 2.8 percent in January, and not far off the ECB's two-percent target.

At the same time the outlook is bleak, with the eurozone narrowly dodging a technical recession in the second half of 2023, weighed down by a poor performance in its biggest economy, Germany.

While slowing inflation and a worsening economy should bolster arguments for rate cuts, inflation's downward path has been bumpy and officials remain worried about completing "the last mile" to the central bank's target.

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The Frankfurt-based ECB's governing council is widely expected to hold the benchmark deposit rate steady at a record four percent for a fourth straight meeting on Thursday.

The ECB "is in no rush", Ann-Katrin Petersen from BlackRock Investment Institute told AFP.

"It still considers its inflation fight unfinished."

Nevertheless, HSBC said that the "meeting will be closely watched by investors looking for any guidance on the timing of the first cut and the subsequent pace of easing".

Investors will also be keeping an eye on the ECB's updated forecasts due to be released alongside the rate decision, with a slight downward revision expected for this year's GDP growth as well as inflation.

Wage worries

Inflation in the 20-nation eurozone surged in 2022 when Russia's invasion of Ukraine sent food and energy costs soaring, with the situation compounded by pandemic-related supply chain woes.

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While the shocks triggered by the Ukraine war have eased, concerns have shifted to inflation in the service sector and wage growth, as workers push for bumper pay rises to combat higher prices.

"With many pay negotiations outstanding, the ECB might want to see more evidence that wages are moving in the right direction," said HSBC.

Heightened geopolitical tensions in the Middle East have also added to worries that inflation could rebound. Yemeni rebels' attacks on Red Sea shipping have led to shipping companies avoiding the vital trade route, while a spillover of the Israel-Hamas war could impact oil prices.

According to minutes of the governing council's last meeting in January, members stressed that "continuity, caution and patience were still needed, since the disinflationary process remained fragile and letting up too early could undo some of the progress made".

But there is little doubt that when the ECB does move again, it will be to reduce borrowing costs.

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"There might be a hold, and hold, and a hold, and a hold, but the next move will be downward," ECB President Christine Lagarde said at the end of January.

Speculation had risen at the end of last year that a cut could come as soon as March, as inflation started dropping heavily.

But these expectations evaporated as price rises proved stubborn, with underlying inflation -- stripping out volatile energy and food costs -- in particular not coming down as fast as hoped.

Economists are now betting on a first rate reduction in June and after that, only a slow-moving process.

"We expect the ECB to only very gradually engage in a series of rate cuts," said ING economist Carsten Brzeski.

"At least for this year, rate cuts by 25 (basis points) at meetings with new macro forecasts look like the most plausible scenario for this cautious and gradual rate cut cycle."

Source: AFP