The European Central Bank (ECB) expects that the current slowdown in the Eurozone economy will help to bring down inflation in the region. This was stated by Boris Vujcic, a member of the ECB’s Governing Council and the head of Croatia’s central bank, in an interview with the Reuters Global Markets Forum on Friday.
Vujcic acknowledged that economic growth in the Eurozone is weaker than the regulator had projected, with growth recorded at 0.3% in the second quarter. He highlighted that if the economy slows down even faster, it will bring inflation down faster as well. This could potentially allow the ECB to cut interest rates sooner or more aggressively, bringing an end to its current tightening campaign, which has seen borrowing costs increase from -0.5% to 3.75% in just over a year.
However, Vujcic made it clear that the ECB will only be able to make rate cuts once it has clear evidence that inflation is on a steady course towards its target rate of 2%. The latest report from the European statistical agency Eurostat shows that inflation in the euro area remained unchanged in August at 5.3%, more than twice the target rate.
Vujcic also mentioned that the labor market in the Eurozone is still producing quick wage growth, which creates a risk of continued price spikes. He stated that as long as wage pressures remain, it will be difficult to achieve the last mile of disinflation.
The ECB policymaker also warned that if price growth stalls above the target rate, the central bank may be forced to implement more rate hikes.
Although Vujcic expressed caution about the location of the terminal rate, he predicted that the ECB will reach this rate soon. The terminal rate refers to the lowest level of interest rates that the central bank believes is necessary to maintain price stability and support economic growth.
Markets, however, are less cautious and have been encouraged by the drop in core inflation, which excludes energy and unprocessed food. This indicator, seen as a bellwether for inflation developments, fell to 6.2% in August from 6.6% in July. Experts polled by Reuters predict that the ECB will keep interest rates unchanged at its next meeting later this month and throughout the rest of the year, with rate cuts expected in mid-2024.
In conclusion, the ECB expects that the current slowdown in the Eurozone economy will help to bring down inflation. However, rate cuts will only be possible once inflation is on a steady course towards the target rate of 2%. The strong wage growth in the labor market poses a risk of continued price spikes. Despite some uncertainty about the terminal rate, the markets remain optimistic, encouraged by the drop in core inflation.
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