Sometimes it is better to break a promise than to take it to extreme consequences. That’s what Robert Holzman must have been thinking before attending the European Central Bank meeting this Thursday, where he was the only one to say no to the first interest rate cut since 2016. stimulus plan (bond purchases) in the eurozone or any other measure with a certain expansionary overtones in monetary policy, the governor of the Austrian central bank enters the scene, a “hawk” (he always advocates a more restrictive monetary policy) among the “hawks” of the ECB, of which there are many. This 75-year-old economist with a charming old man’s face is a staunch advocate of high interest rates and tight monetary policy that curbs profligacy. His notorious consensus-breaking gesture underscores fears within the council that a misstep would undermine the fight against inflation and undo all the work done since 2022, simply because he would cling to his promise to cut rates in June. A promise that can be very expensive.
The European Central Bank (ECB) cut three key interest rates by 25 basis points this Thursday, marking the first rate cut since 2016 (eight years) and the first deposit rate cut since 2019 (five years). The almost symbolic move, which comes after 10 consecutive rate hikes between 2022 and 2023, has sent the price of money in the eurozone to an all-time high.
This increase was necessary as the consumer price index in the eurozone spiraled out of control, even exceeding 10% in October 2022. Now that prices are again close to 2%, the ECB decided to implement a rate cut, which, however, was criticized from various points of view (not only by ECB hawks, but also by analysts) because it came at just the worst time. moment: when the economy begins to wake up and inflation has risen slightly again under the impulse of a strong increase in wages. The ECB keeping its word could end up being very costly.
However, Holtzmann went further, according to Reuters, breaking the central bank’s “usual” unanimity when voting on major decisions. There were speculations about other names, such as that of the Belgian Pierre Wunsch, but in the end he turned out to be the “great falcon”. Although each member of the Board of Governors has his own opinion, this body usually respects and votes on the proposal of the Executive Committee (consisting of central bank officials such as President Christine Lagarde, Vice President Luis de Guindos, Chief Economist Philip Lane or German economist Isabelle Schnabel. which the press has recently considered the organ’s “baton”).
Holtzman’s case is a little special. For example, when the market was pricing in more than five ECB rate cuts in the eurozone for the whole of 2024, an Austrian banker assured that it was “premature” to discuss at this point (December 2023) about a possible reduction in interest rates. “Although we are faced with a series of rate hikes unprecedented in ECB history (ten consecutive hikes), there is still no guarantee that interest rates will fall in 2024,” he warned. Tightening and normalizing monetary policy “is already showing its impact on reducing inflation, but it would be premature to think about cutting interest rates now,” he insisted.
“Holzmann stated that decisions must be based on data. This means that the previous reduction commitment may have been largely motivated by political reasons. In fact, the ECB raised its inflation forecast to 2.2% on average for next year, but kept it at 1.9% for 2026,” explains Axel Botte, head of market strategy at Ostrum AM, in a note to clients.
Veteran Holtzman’s stubbornness meant that yesterday Lagarde had to do what she least likes: admit to reporters that not all Council members were rowing in the same direction. One might conclude that the Council was between a rock and a hard place: refusing at the last minute a widely telegraphed rate cut would have been a serious blow to its authority. But complying with this decision would require some internal compensation and would still jeopardize unanimity.
“Premature” decision
Some analysts justify Holtzman’s doubts and They directly consider the June reduction to be “premature.”. “We believe that the ECB has already cut interest rates prematurely. Unfortunately, he had previously committed to these interest rate cuts rather than focusing primarily on the data, which generally suggests a wait-and-see approach. Kremer, chief economist at Commerzbank, strongly defends this position. The strategist believes that Doves dominate ECB Governing Council and therefore “it will probably be many months before the ECB admits that the inflation problem is far from being solved.”
“In truth, the (ECB) did not have much of a choice not to do it (cut), given that almost since the beginning of the year it has been telegraphing this cut, repeatedly mentioning the expression “by the end of spring.” In other words, not making a move would lead to an important loss of trust “European Monetary Institute,” confirms Pedro del Pozo, director of financial investments at Mutualidad. “The ECB has eased monetary policy, but to get votes it has had to come to terms with rising inflation expectations,” says Andrew Brenner of NatAlliance. Securities.
“We believe that the ECB has taken this decision because it considers this rate cut to be relatively safe (there is no significant risk of re-stimulating subsequent inflation pressures),” said Hugo Le Damany and Francois Cabot of AXA IM. However, they emphasize, the ECB immediately reminded that internal pressure on prices remains strong. “This duality surprises usas they have not given further guidance for short-term reasons, especially since the current situation is not much different from the situation in March (where the June decision was probably taken),” they note.
Both experts are of the opinion that, based solely on data, the current economic surprises are the same. Therefore, they regret, “it is difficult for us to understand the reason for the lack of any guidance on holding meetings in the short term.” “This probably confirms that the decision was not made by mutual consent, but rather is the result of a previously achieved commitment. Otherwise, the Council (at least the majority) would be tempted to be more peaceful,” they decide, calling for an explanation of all this in the message of the July meeting.
“The ECB faces a credibility problem. It has started cutting rates, although it expects inflation to remain above its 2% target in the second half of next year… There is a risk that the improvement in demand conditions in the eurozone will become increasingly stronger. check the stability of the ECB’s medium-term inflation forecasts. unpleasant choice“: Protect your inflation credence by stopping the rate-cutting cycle, or accept that 2% is the new floor for eurozone inflation and not a credible target,” urges Cedric Gemel of Gavekal Research.
The blow to the ECB’s authority has Commerzbank’s Kremer looking back: “Compared to other central banks, the ECB it took time to raise interest rates in 2022 and now he is one of the first to download them. Ultimately, this reaction function is an important argument for us as to why inflation should be well above 2% in the coming years.”
Proof of the “political” burden of this Thursday’s decision, continues Ostrum’s Botte, is that Lagarde ‘it was difficult to justify the decline’ “Wage growth should be around 4% until the end of 2024. The ECB’s message is difficult to understand because the ECB’s rate cuts are being carried out simultaneously with quantitative tightening (balance sheet contraction),” he adds. That same Friday, in an interview with Onda Sero, Vice President From Gindos faced the same thing: on the one hand, he was convinced that the 2% target would be reached next year, but on the other, he warned that “uncertainty is the highest in decades,” while acknowledging that inflation would accelerate in next year. the coming months. Other ECB voices who appeared in the media this Friday (German Joachim Nagel, Estonian Madis Müller, Latvian Martins Kazaks, Irishman Gabriel Makhlouf or Schnabel herself) simply defended the inconveniences associated with accepting a certain rate path. cut.
With these internal problems, there is a risk that the most political aspect will affect the economic one. Economists at Commerzbank are clear that future interest rate decisions will depend primarily on inflation and wage data. And with recent strong wage growth, inflation is likely to stabilize at 3% rather than 2% by the end of the year, especially as commodity inflation (excluding energy and food) falls. It is basically over, they warn, and services are not giving up.
“Excluding volatile energy and food prices, consumer prices rose more strongly year-to-date, at an annualized rate of 3.5%, well above the inflation target of 2%. Moreover, there is still no sign of a downward trend. in the increase in the contract wage index in the euro area, and the latest wage agreements are still slightly higher than the increase in the wage index, which has increased significantly over several months. more pricing power later this year,” writes Kremer, the German bank’s chief economist.