Inflation: ECB not raising rates for the first time since July 2022

Europe 1 with AFP // Photo credit: Daniel ROLAND / POOL / AFP 19:03 p.m., October 26, 2023

The European Central Bank (ECB) left rates unchanged on Thursday, after 2022 straight hikes, warning that inflationary risks, exacerbated by the war in the Middle East, are still too high to consider any cuts. After raising its key interest rates to their highest level ever, this pause in the unprecedented monetary tightening cycle, launched in July <>, was expected by the markets. The guardians of the euro, who met in Athens on Thursday, want to give themselves time to assess the direction the eurozone economy is taking.

Inflation continues to decline

Since September and the tenth consecutive tightening of the screws by the ECB, the economic situation has darkened while inflation has deepened its decline from 5.2% in August to 4.3% in September, year-on-year, to return to its October 2021 level. This is a sign that there is already "a very strong transmission of monetary policy, in the banking sector in particular, and that the financing of the economy is directly affected," Lagarde said.

Further effects on the economy "are to come", she predicted, as the ECB's objective is to tighten access to credit for households and businesses in order to weigh on demand and stem price rises that have soared over the past 18 months. The main key interest rate on deposits, the benchmark for credit in the euro zone, has thus been maintained at the historically high level of 4.00%. The refinancing rate and the marginal lending facility rate are 4.50% and 4.75%, respectively.

The ECB's message is that "patience is now the key," Deutsche Bank economists said. "We have to be stable and stand firm," Lagarde told reporters.

"Rates will remain at their current levels for the foreseeable future"

The pause in monetary tightening should also provide a better gauge of the effect of geopolitical tensions linked to the war between Israel and Hamas, which have raised fears of a surge in the cost of oil and energy. The European Central Bank (ECB) is "very attentive" to the economic risk posed by this conflict, which comes on top of the upheavals caused since February 2022 by the war in Ukraine, Christine Lagarde said.

Energy prices have become even "less predictable" and "heightened geopolitical tensions could push them higher in the near term," she said. In this context, there is no point in waiting for a rate cut in the near future, even if weak activity raises fears of a contraction in the eurozone's gross domestic product in the third quarter. "Having a discussion about a cut is totally premature at the moment," said Christine Lagarde, who also did not rule out further rate hikes if the economic situation requires it.

"Only by keeping rates at their current restrictive level for long enough can the ECB be sure that inflation will return to its 2% target," said Mark Wall, economist at Deutsche Bank. The ECB is "sitting on a plateau," Berenberg's Holger Schmieding believes. "In the absence of any major surprises, rates will remain at current levels for the foreseeable future," he said.

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"It's too early to cut interest rates," said Clemens Fuest of the German economic institute IFO. "For that to happen, inflation needs to continue to fall. Due in part to high wage agreements and energy price risks, there is no guarantee that this will happen." In December, the monetary institution will be able to decide based on the latest inflation figures and a new set of economic projections for 2026.

Most economists don't expect a rate cut until the second half of 2024 at the earliest. "The ECB has no room to cut rates next year," given the ever-present inflation risk, said Jörg Krämer, an economist at Commerzbank.