ECB: now’s the time to accelerate
“Have we broken the neck of inflation? Not yet. Are we in the process of breaking that neck? Yes.” Using one of those metaphors for which she has such a knack, Christine Lagarde emphasised the European Central Bank’s (ECB) growing confidence that inflation in the eurozone is rapidly subsiding. Indeed, the latest CPI data is extremely reassuring. In September, there was an annual rise of just 1.7%, the lowest figure since April 2021 and, symbolically, the first time that the rate has dropped below the 2% threshold in over three years. Of course, core inflation is still a little high at 2.7% year-on-year, driven by services inflation, which is still rising at 3.9% YoY. But the recent trend is clearly down and the make-up of this inflation figure is also reassuring. Inflation on goods and services for which prices are administered – which Eurostat defines as prices set or influenced by governments – remains high, at 4.5%. But inflation on goods and services that are primarily driven by the equilibrium of supply/demand has declined significantly, to 1.5%. And the ECB’s mission is primarily to control this inflation which is caused by price fluctuations on free markets. It is therefore logical that Christine Lagarde seems to be rather confident and has even mentioned the risk of downside surprises on inflation from now on.
In parallel, the ECB President emphasised the plethora of recent data indicating a deterioration in growth momentum, explaining that this environment was affecting the inflation outlook, once again on the downside. It was these elements that encouraged the Governing Council to decide on another interest rate cut of 0.25% at the 17 October meeting – an outcome that looked highly unlikely just a month ago. For all that, and although we can reasonably expect more gradual cuts in coming meetings, the ECB has barely shifted its stance on the future trajectory of its monetary policy. It is still sticking to its “data-dependent” rhetoric, has given no indication of the speed of monetary easing to come, and not the slightest hint of the possibility of an acceleration. However, Christine Lagarde emphasised that, at this stage, monetary policy remained restrictive and that this would still be the case after this October rate cut. And all this as inflation is slowing more quickly than anticipated by the ECB itself, and the already mediocre outlook for growth continues to deteriorate.
The question is therefore legitimate – why is the ECB not being more proactive? Undoubtedly, growth in the eurozone needs support – Germany is at severe risk of falling into technical recession in the third quarter, and the prospects for growth in France will be largely undercut by the measures announced in the 2025 budget of the Barnier government. What’s more, the wave of monetary easing has now spread worldwide, clearly restricting the risk of a devaluation of the euro. Moreover, it is striking to note, that should the US Federal Reserve (Fed) cut rates by 0.25% at its meeting at the beginning of November, it will have cut its rates by as much as the ECB (0.75% in total). US growth should be above 2.5% in 2024, remaining close to 2% in 2025 – if employment does not slow further – whilst eurozone growth is unlikely to top 0.7% this year and will struggle to reach 1% next year.
We could of course argue that, unlike the Fed and other central banks, the ECB does not have an explicit mandate to support growth or employment. Nonetheless, its main mission is, without undermining price stability, to support the goals of monetary union, which include growth. Christine Lagarde has herself also emphasised, quite skilfully, that any deterioration in the growth outlook could have a downside impact on inflation. In other words, it could drive inflation too low, which would provide grounds for ECB action. In principle therefore, the ECB already has all the justification it needs to accelerate the speed of monetary easing. Only an excess of caution vis-à-vis inflation and – what is more likely – the difficulty of convincing its most orthodox members to accept this eventuality could be holding back the ECB. Yet the lessons of history should serve as a reminder to the most hesitant. The procrastination, errors and poor calibration of monetary policy between 2008 and 2011 brought a high cost in the last economic cycle, with a lost decade for the eurozone: its GDP grew by just 13% between 2010 and 2019, whilst GDP in the US rose by 26%. The ECB would do well to remember this, as the famous saying (often attributed to Seneca) goes: “Errare humanum est, perseverare diabolicum[1]”.
Final version of 18 October 2024 – Enguerrand Artaz, Fund Manager, LFDE