ECB policy must stay restrictive into 2025: Economist

PARIS: The European Central Bank is ready to cut interest rates next month but policy must continue to be restrictive this year as wage growth will not normalize until 2026, ECB chief economist Philip Lane told the Financial Times.

FILE PHOTO: Signage is seen outside the European Central Bank (ECB) building, in Frankfurt, Germany, July 21, 2022. REUTERS/Wolfgang Rattay.

The ECB has all but promised a rate cut for June 6, so the debate has shifted to subsequent moves and markets have dialed back their expectations, betting on just one more cut this year.

“Barring major surprises, at this point in time there is enough in what we see to remove the top level of restriction,” Lane told the FT in an interview published on Monday. “The best way to frame the debate this year is that we still need to be restrictive all year long,” he added. “But within the zone of restrictiveness we can move down somewhat.”

While Lane made no explicit comment about the July policy meeting, a string of policymakers including fellow board member Isabel Schnabel have already said that a second step should not come quite so soon. Wage growth is expected to “visibly” decelerate next year and policymakers can then debate normalizing policy.

At 4 percent, the ECB’s deposit rate holds back growth and there is little debate that the first few cuts, at least until 3 percent but possibly further, merely remove restriction rather than provide stimulus.

“We need to see more progress (on inflation) before we move from maintaining the restrictive phase to thinking about normalization,” Lane added. Lane said ECB policymakers needed to keep rates in restrictive territory this year to ensure that inflation kept easing and did not get stuck above the bank’s target, which “would be very problematic and probably quite painful to eliminate”.

A key wage indicator accelerated last week, spooking some but Lane said the figure was well anticipated and a slowdown was already in the works.

“Deceleration does not necessarily mean an immediate return to steady state,” Lane said. “This year the adjustment is clearly quite gradual.”

The European Central Bank has plenty of room for rate cuts and current market expectations for easing over the long-run are reasonable, ECB policymaker Francois Villeroy de Galhau said in a newspaper interview on Monday. After a first rate cute next month that Villeroy described as a “done deal”, debate among ECB policymakers remains open about how fast and far to keep easing after that.

Villeroy, who is also the governor of the French central bank, has repeatedly made the case for the ECB adopting an approach of “maximum optionality” after June. In an interview with German newspaper Boersen Zeitung, he pushed back against suggestions that the ECB should only cut once a quarter when its economic forecasts are updated, which would exclude a July move.

“I don’t say that we should commit already on July, but let us keep our freedom on the timing and pace,” Villeroy added. Looking through the debate about the short term, market analysts surveyed regularly by the ECB expect it to cut its main rate over time to 2 percent, which Villeroy described as “not unreasonable”. — Reuters.