MNI INTERVIEW: ECB Pause Likely In Sept-ExBank Of Cyprus Chief

The European Central bank is likely to pause interest rate hikes in September, a former Governing Council member told MNI, with inflation trending downwards and risks to the growth outlook becoming increasingly pronounced.

“We don't know what will happen between now and September, but if we assume there are no unpleasant inflation surprises between now and then, I think they would pause,” said Panicos Demetriades, governor of the Central Bank of Cyprus from 2012-14 and now Emeritus Professor of Financial Economics at the University of Leicester School of Business. (See MNI SOURCES: Data Deluge Clouds Early ECB September Rate Call)

“The fact that the Fed paused would certainly have a bearing on it. Having peaked in October 2022, inflation is heading downwards. The ECB doesn’t follow the Fed, but what the Fed does certainly creates a comfort zone for central bankers," he said in an interview.

Earlier this week Klaas Knot, the usually hawkish boss of the Dutch central bank, said rate rises post-July, for which meeting the ECB has signalled a 25bp hike in the deposit rate to 3.75%, would be "at most be a possibility, but by no means a certainty."

Having been late to raise rates at the beginning of the cycle, the ECB now needs to avoid “error correction,” Demetriades said, with any “unnecessarily hawkish” rate rises in Q4 increasing the chances of a recession. (See MNI INTERVIEW: ECB Rate Hikes, German Downturn Threat To CESEE)

GROWTH OUTLOOK

China’s slowdown towards more mature growth rates will undoubtedly have a negative impact on demand for European, and in particular German goods, he said, and should be taken into account in rate decisions.

“A further hike could endanger growth prospects and labour market prospects. I just can't see people becoming more confident, spending more money, under the current conditions. I can't see growth being higher than projected. So I cannot see how by October they will feel they have to hike interest rates again, unless something unexpected happens.”

While headline eurozone inflation fell to 5.5% in June from its 10.6% peak last October, progress is set to become increasingly harder. Getting from 3% to 2% within the medium-term forecast horizon will be difficult, Demetriades said, adding that because inflation was below target for so long prior to Covid and the war in Ukraine, policymakers can afford to tolerate slightly above-target levels for longer.

“That may be the only way forward. But you do have to also worry about making sure that you anchor inflation expectations. If it takes another two years to go from three to 2% it’s not worth it. Being 1% above target for two years would be bad for the reputation of the ECB.”

Pay increases, which the ECB has identified as a potential source of upside risk to price pressures, are unlikely to materially alter the outlook, Demtriades said, with consumers and wage negotiators expected to place greater weight on headline rather than core inflation in future discussions.

“I don’t think the ECB is expecting to see strong second-round effects. Inflation is feeding into price inflation, but only the first round. At the same time, the whole picture - the comments you get at the meetings and the statement - is not always totally consistent.”