European Central Bank Hits Pause on Interest Rate Cuts as Inflation Pressures ‘Still High’

Christine Lagarde, head of the European Central Bank, speaks at a press conference in Frankfurt, Germany, on Oct. 28, 2021. Thomas Lohnes/Getty Images

The central bank of the 20 European Union countries that use the euro as their currency has decided to keep its benchmark interest rate unchanged, citing elevated price pressures, especially in services, with policymakers saying this is likely to translate into above-target inflation lasting well into 2025.

The governing council of the European Central Bank (ECB) voted on July 18 to hold the key rate unchanged at 3.75 percent, after making an initial quarter-point cut at its earlier meeting in June.

The council justified the decision to hit pause on cutting rates by citing economic data suggesting the central bank’s fight to bring inflation down to its 2 percent target would take longer than expected.

Inflation in the eurozone fell to 2.5 percent in June, from a peak of 11.6 percent in October 2022, with progress on the last mile toward the target taking longer than policymakers had hoped.

The ECB’s monetary policy remains tight, keeping borrowing costs high and crimping demand, the council said in its statement. Despite restrictive monetary settings, “domestic price pressures are still high, services inflation is elevated and headline inflation is likely to remain above the target well into next year,” the council said.

Elevated service-sector inflation was a problem recently flagged by the International Monetary Fund (IMF), which predicted that this factor would cause overall inflation across the world, including in the United States, to come down more slowly in the latter half of the year.

Higher interest rates make it more expensive to borrow money, spend, and invest, resulting in a cooling effect on demand and relieving inflationary pressures. Persistently high inflation means that the much-anticipated rate cuts by the ECB and the U.S. Federal Reserve could be delayed.

Whether Europe’s central bank cuts rates at its September meeting remains an open question, with policymakers making clear they were “not pre-committing to a particular rate path” and that their decision would be based on incoming economic and financial data.

“We are determined to ensure that inflation returns to our two percent medium-term target in a timely manner,” Christine Lagarde, ECB president, said in a July 18 statement after the interest rate decision was announced. “We will keep policy rates sufficiently restrictive for as long as necessary to achieve this aim.”

The decision means European homebuyers and businesses waiting for lower interest rates will have to wait a little longer to reap the benefits of lower borrowing costs.

The ECB’s stance, for now, resembles that of the Fed, which investors overwhelmingly expect will hold the benchmark interest rate at an unchanged level of 5.25–5.5 percent at its July policy meeting, although markets put the odds for a September rate cut at about 99 percent.

In terms of economic activity in the euro area, Ms. Lagarde said growth slowed in the second quarter, with services being the key force driving the expansion while industrial production and goods exports remained weak.

Inflation in the euro area is likely to fluctuate around current levels for the rest of the year, the ECB chief said, with next year’s declines driven by restrictive monetary policy and weaker labor cost growth.

“Domestic inflation remains high,” Ms. Lagarde said. “Wages are still rising at an elevated rate, making up for the past period of high inflation.”

Business profits contracted in the first quarter and evidence suggests that profits will continue to be dampened in the near term, helping to offset the inflationary effects of higher wage growth, according to Ms. Lagarde.

In the United States, Federal Reserve Chair Jerome Powell said this week that the central bank is becoming more convinced that inflation is headed back to its 2 percent target.

Annual U.S. inflation was 3 percent in June, down from 3.3 percent in May.

In a statement that bolstered market hopes for an imminent rate cut, Mr. Powell said that the Fed wouldn’t wait until inflation drops to 2 percent before cutting.

The current 5.25–5.5 percent level of the Fed’s benchmark interest is the highest in 23 years.