Eurozone’s central bank remains as hawkish as ever

The European Central Bank (ECB), as expected, kept interest rates unchanged at a record high on Thursday and reaffirmed its commitment to fight inflation, giving not a hint that policymakers are starting to contemplate policy easing.

The ECB ended its fastest rate-hiking cycle in September but has been adamant that even discussing a reversal would be premature, since price pressures have yet to be fully extinguished and many wage negotiations have yet to conclude.

Investors, however, are betting the ECB is getting it wrong on both growth and inflation and will be forced into an about-face, delivering five rate cuts in rapid succession from April.

But the ECB did not signal such a pivot on Thursday and made only nuanced changes in its statement, repeating its longstanding guidance that holding interest rates at the current level for sufficiently long will bring inflation back to target.

“The governing council’s future decisions will ensure that its policy rates will be set at sufficiently restrictive levels for as long as necessary,” the ECB said in a statement.

The bank said that inflation trends “broadly” confirmed its previous assessment but it removed a reference in previous statements to elevated domestic price pressures and strong labour cost growth.

The bank said it will keep to a data-dependent approach, meaning it is not committing to any particular policy path and reserves the right to adjust interest rates as needed.

ECB president Christine Lagarde and chief economist Philip Lane have recently pointed to first-quarter wage settlements, for which figures will become available in May, as a relevant gauge. Some see it as a clue that a first rate cut could come at the ECB’s June meeting.

“The governing council’s interest rate decisions will be based on its assessment of the inflation outlook in light of the incoming economic and financial data, the dynamics of underlying inflation and the strength of monetary policy transmission,” the central bank added.

The ECB’s pushback has had some influence on financial markets but investors still see 125 basis points of rate cuts this year, or five moves, with the first in April or June.

The big discrepancy in expectations largely stems from a different outlook on growth and just how much past rate hikes are slowing activity across the 20 economies that use the euro currency.

The ECB expects household and government spending to drive a recovery, but data appear to paint a bleaker picture, with manufacturing remaining in recession and services cooling.

The eurozone was probably in recession last quarter and got off to a slow start in January, making the current quarter the sixth in a row with broadly flat or negative growth. A long predicted recovery keeps getting pushed further out.

A weak economy, along with muted commodity prices and high interest rates, will keep stifling inflation, which stood at 2.9% in December and is not expected by the ECB to fall back to its 2% target until 2025.

Many disagree with that projection. “We continue to expect headline and core HICP inflation rates to fall to 2% before the middle of this year a year or more earlier than the ECB forecasts,” Deutsche Bank economists said. The acronym HICP refers to the eurozone’s harmonised index of consumer prices.

Lower inflation would mean rising real interest rates, effectively policy tightening in a recessionary environment.

“This would raise the risk of an outright recession and a genuine shock to the labour market,” Deutsche Bank added.

Some think that the ECB’s insistence that even more evidence of disinflation is needed for it to act raises the chance of a policy error.

“Having overlooked the negative effect of monetary tightening on growth until now, the ECB remains biased towards cutting too little, too late,” TS Lombard’s Davide Oneglia said.

“The ECB has less to worry about inflation and fewer excuses to keep monetary policy tight than officials think, but overtightening habits die hard.”