MNI INTERVIEW: ECB Likely To Cut By Late 2024 - Schularick

The European Central Bank is likely to start cutting rates around the end of 2024, as wages growth moderates and with monetary conditions already exerting a drag on investment, leading German economist Moritz Schularick told MNI, adding that over-tightening could raise risks of financial instability.

The ECB is likely to pause on rates later this week, said Schularick , president of the Kiel Institute for the World Economy and Professor of Economics at Sciences Po, Paris. While policymakers should not underestimate the stickiness of inflation, they should be wary of the risks of overtightening, with any further bond market selloffs likely to have an increasingly significant effect on demand, he said in an interview. (See MNI SOURCES: ECB Doves Wary Of December Push For Hike).

“There is more and more evidence that tight monetary policy can really hit supply, that it has quite persistent attacks on innovation, on firm growth,” he said, “It really matters whether people are willing to spend on your new product. So, I think it’s a good time now to wait and see.”

There is no indication upcoming German wage negotiations will be based on expectations for future inflation, said Schularick, 2022 recipient of the Leibniz-Prize, Germany's foremost economic research award.

“It’s mainly a backward-looking, redistribution story between companies that have raised prices and/or workers whose purchasing power had declined. If we end up getting demands for 8.5% translating into agreements of 5-6%, that's something that doesn't fundamentally change the picture," he said. (See MNI INTERVIEW: ECB To Look Through Oil Spike - Ex-BdF Official).

Higher rates could also erode financial stability, said Schularick.

“We had the warning signs in the spring that this high interest rate environment is problematic for balance sheets. We don’t yet have a recession, but if or when we do [...] I would be concerned for financial stability," he said. (See MNI INTERVIEW: ECB Growth Assumptions Over-Optimistic).

German banks would be vulnerable in the event of sharp corrections in asset prices, he added.

FINANCIAL STABILITY

“Real estate crises are always systemic,” he said. “The banks will be in trouble. Especially if you look at German banks, they’re not in great shape, so the double-whammy of a recession and higher interest rates and asset quality problems will really hurt.”

The turndown in the German business cycle has shifted attention to long-run structural issues, notably its declining growth potential due to demographic changes and its “ridiculous backwardness when it comes to digital and network infrastructure,” Schulerick said.

While there are hopes of a short-term bounce in German household spending, there remains considerable uncertainty over where growth will come from in the medium- to longer-term, amid a lack of clear political leadership.

“Basically, no one can imagine how this country will look in 10 years,” Schularick said. “We clearly don't want to give up on the strong industrial base, but there needs to be a vision for a green version of it and the new, green infrastructure investment, which does not really exist here, but happens more in Tennessee at the moment.”

Still, Germany is not alone in feeling the negative effect of declining Chinese demand, he noted.

“South Korea has very similar problems to Germany, but it’s far away from Russia and Ukraine,” he said.