Business

ECB keeps interest rates on hold at record high 4%

Central bank maintains benchmark deposit rate as it signals inflation falling in line with its expectations

Traders now price a 66 per cent chance of a first interest rate cut in April, down from around 70 per cent ahead of the announcement. Photograph: Kirill Kudryavtsev/AFP via Getty

Martin Arnold
Thu Jan 25 2024 - 13:30

The European Central Bank has kept its key interest rate on hold at a record high of 4 per cent as it signalled inflation was falling in line with its expectations.

The Frankfurt-based bank’s governing council maintained its deposit rate for the third consecutive meeting, repeating its determination to hold borrowing costs at “sufficiently restrictive levels for as long as necessary”.

“The consensus around the table of the governing council was that it was premature to discuss rate cuts,” ECB president Christine Lagarde said at the central bank’s press conference on Thursday afternoon.

She said that the pick-up in inflation in December had been “weaker than expected” and forecast that price pressures would “ease further over the course of the year”. But Ms Lagarde warned that rapid wage growth and lower productivity were “keeping price pressures high”.

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The ECB president outlined both upside and downside risks to inflation, but added that it could “fall faster than forecast in the short term” if energy prices continued to drop in line with lower market expectations for oil and gas prices.

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The ECB was observing the disruption caused by the conflict in the Middle East “very carefully”, Ms Lagarde said. “Shipping costs are increasing and delivery delays are increasing,” she said, adding this was “an additional risk” for the economy.

Markets showed little reaction to the decision to keep rates on hold, which had been widely anticipated by investors. The euro was up marginally at $1.0878 against the dollar, roughly where it had traded ahead of the ECB’s announcement.

Investors have been watching for clues from central bankers on how fast inflation is likely to fall and when borrowing costs could start to be lowered.

“We will see interest rate cuts over the course of the year, but I don’t think the markets are correctly assessing the timing and extent,” Jörg Asmussen, a former ECB board member and current head of Germany’s insurance association, wrote on social media site X.

Economists have been cutting their forecasts for euro zone growth and inflation this year after weak data on industrial production, producer prices, business orders and retail sales pointed to a slowing economy.

Yet analysts still worry high wage growth and supply chain disruption caused by attacks on ships in the Red Sea could keep inflation high.

Western central banks are becoming more confident they could soon start cutting interest rates as inflation falls closer to their targets. But they are weighing the risk of a resurgence in price pressures if they lower borrowing costs too soon against the danger of doing unnecessary damage to growth and jobs by waiting longer than needed.

Central banks in Japan, Canada and Norway have also left policy unchanged this week, with similar outcomes expected from the US Federal Reserve and the Bank of England next week.

The ECB predicted last month that inflation would slowly drop to its 2 per cent target by mid-2025 and Ms Lagarde said last week that a rate cut “is likely” by the summer. But price growth has undershot the bank’s forecasts for the last couple of months, leading investors to bet this trend will prompt it to start cutting rates as early as April.

The gloomy outlook for the euro zone economy was underlined by the Ifo Institute’s closely watched survey of German businesses, whose business climate index showed an unexpected fall in its business climate index by 1.1 points to 85.2, its lowest level since May 2020. Economists polled by Reuters had forecast a jump in business confidence would lift the index to 86.7.

Euro zone inflation has dropped steadily from a peak of 10.6 per cent in late 2022 to 2.4 per cent in November. But in December it picked up to 2.9 per cent due to the phasing out of energy subsidies.

Core inflation, which excludes more volatile energy and food costs to give a better idea of underlying price pressures, has been stickier at 3.4 per cent in December. – Copyright The Financial Times Limited 2024

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