The ECB resists lowering rates despite the fact that the European economy has been stopped for more than a year

The European Central Bank (ECB) has maintained historically high interest rates for four months since the establishment of the euro, as it searches for the right moment to declare victory over inflation. However, the European economy continues to struggle while the ECB remains cautious about the potential resurgence of inflation.

The eurozone’s GDP has remained stagnant for a year, with no real growth experienced since the third quarter of 2022. This is largely due to Germany, which is facing an industrial crisis and hindering growth in the euro countries. Leading indicators suggest that this stagnation continued into the final months of 2023.

Although the eurozone has not slipped into negative territory or experienced high unemployment rates, the ECB is facing increasing difficulty in justifying its high interest rates as inflation approaches its 2% target. In December, inflation reached 2.9%, highlighting the need for the ECB to adjust its narrative on maintaining high rates.

According to the ECB’s own analysis, inflation is projected to decrease throughout 2024 and hover around 2% towards the end of the year. ECB President Christine Lagarde emphasized that the disinflationary process is underway, and she previously stated that interest rate cuts would not occur until the summer.

The main concern for central bank decision makers is the rapid rise in wages across euro countries. Negotiated remunerations indicate a year-on-year increase of 4.7% in the eurozone overall, which is a historical high resulting from the recovery of purchasing power lost during a major inflation crisis.

Lagarde is closely monitoring the pace of wage increases to ensure they do not lead to second-round effects that could contribute to inflationary pressures. However, conclusive data on salaries will only be available in mid-year. Meanwhile, it appears that companies are absorbing the cost of salary increases without passing them on to consumers.

Despite the ongoing challenges, the ECB is not currently facing pressure to rapidly reduce interest rates as a serious recession does not seem imminent. ING analysts suggest that the ECB’s projections indicate a potential revival of growth in the coming months.

Interest rates play a vital role in regulating the economy. High rates discourage borrowing and investment, leading to reduced spending, lower demand, and subsequently lower prices. This cooling effect on the economy helps to combat inflation but can also impact economic growth, employment, and public finances.