ECB pushes inflation litmus test to 2025 and hopes to hit its target due to eurozone weakness

“Be careful what you wish for, because it just might come true.” The minutes of the September meeting of the European Central Bank can be explained by this famous saying. The central bank is seeing more and more signs that its target is close to being achieved, and they estimate that inflation will reach its target in the second half of next year, progress of around 2%. While there are still some gaps that need to be narrowed, such as service sector inflation which remains resilient, the reality is that the eurozone economy is showing signs of stronger weakness than ECB members expected, particularly in consumption and productivity. two fronts that worry them more and more, but which, on the other hand, help them achieve their inflation target. Central bankers hope things will stabilize in the coming months. They warn that rate hikes in 2022 will continue to weigh on the economy for years. The year 2025 will be a serious test.

The ECB’s September meeting ended without major surprises: As expected, the organization cut interest rates by 25 basis points and updated its macroeconomic forecast table, cutting estimates for eurozone growth this year and the next two years by a tenth. The publication of the minutes of the meeting details the most important points that were highlighted in the discussion between the members of the Governing Council and allows us to draw several conclusions. The main one is that the ECB is confident of achieving its inflation target next year.However, this success is linked to the economic deterioration of the bloc’s economy, which is increasingly worrying central bankers.

Signs that inflation is approaching the target are clear: “Most inflation measures, including those with strong future projections, are stable at levels consistent with our target,” the document explains. The only data that continues to worry in this sense is domestic inflation, which is more linked to the services sector, and which Lagarde already warned a year ago was the last hurdle they had to soften to claim victory. “Domestic inflation remains high due to rising wages,” The minutes highlight, but also acknowledge, that “the expected decline in wage growth next year is expected to be the main factor contributing to the final phase of deflation until the target is reached,” the ECB explains.

The organization is therefore fully focused on domestic inflation data, but acknowledges that the situation may change and does not rule out that the pace of rate cuts may have to be accelerated or delayed in the future, depending on the situation. macroeconomic data are published in a context that remains uncertain for central bankers. Of course, ECB members recognize that the current context of the European economy is weak and the fragility shown by the recovery is stronger than they expected, especially in the areas of consumption and productivity. Despite everything, the ECB’s scenario for the coming quarters excludes a recession in the eurozone.

The weakness experienced by the economic recovery in the eurozone is directly related to high interest rates. Minutes from its September meeting show the ECB is closely monitoring the impact that rate hikes in 2022 have had on the economy and believes they continue to weigh on growth in the region. Moreover, they warn that this will likely continue for a long period of time. “Monetary policy continues to influence the economy, and analysis shows that “The effects of rate increases could last several years before they fully wear off.” the document says.

The year 2025 will be a serious test.

Although everything seems to be aimed at achieving the medium-term inflation target, ECB members are reluctant to claim victory. In fact, for them, the uncertainty is still so great that they cannot rule out that inflation will eventually fall well below the 2% target that the organization maintains; We must not forget that already in September the price increase was 1.8%, although the Governing Council expects that in the last months of the year there will be a temporary rebound in prices due to the base effect.

Going forward, if expectations of moderate wage growth are met as expected by the ECB, inflation will reach the ECB’s target in 2025. pace,” the document said, highlighting expectations that “expected wage growth will be tempered by corporate earnings as seen in the latest data.” The ECB’s conclusion is: “it is too early to declare victory”They highlight that “the litmus test will come in 2025, when it becomes clearer whether wage growth has slowed, whether productivity has risen as we expect, and whether labor costs have fallen sufficiently to keep price pressures contained.