The ECB is running out of time to revive euro zone
The author is a Reuters Breakingviews columnist. The opinions expressed are his own.
By Francesco Guerrera
LONDON, Aug 16 (Reuters Breakingviews) -Frankfurt, you have a problem. Business surveys and weakness in Germany suggest that euro zone growth may be flagging. With inflation still high, though, European Central Bank President Christine Lagarde faces a tough choice: keep rates elevated to tame rising prices or cut them quickly to avoid a possible recession. The second option looks best.
Until recently, Lagarde seemed to be safely piloting the bloc’s economy towards a “soft landing” – where inflation comes back down to the ECB’s 2% target and GDP keeps expanding. The 20 countries that share the euro have grown, in aggregate, at 0.3% a quarter for the past six months. Output held up even as tight monetary policy brought inflation down by more than half from last year’s bloc-wide average of 5.4%.
That rosy picture is under threat. A survey of 5,000 euro zone companies by S&P Global recorded the slowest growth in the region since March. And businesses were at their least optimistic about the next 12 months since January. The German ZEW index, which measures the difference between the percentage of financial market forecasters who expect economy to get better and those who think it will get worse, plummeted from 42 in July to 19 in August. Admittedly, smaller economies like Spain and Portugal are doing better, but Germany accounts for almost a third of euro zone’s GDP.
That represents a dilemma for Lagarde, who in June lowered rates for the first time since 2019 but has refused to commit to more cuts. She’s hesitant because the ECB isn’t convinced it has slayed inflation. Teutonic hardliners in its Governing Council point to the rise in headline inflation in July to 2.6% from 2.5% in June, and to stubbornly high services inflation, which was 4% last month.
Lagarde has to choose which prospect is scarier: risk a recession by holding rates high or risk an inflation comeback by cutting them too fast. Of the two dangers, an economic slump looks more troubling. The long period of high interest rates is choking off growth. Net interest payments for euro zone non-financial businesses are at the highest level since 2009, according to BCA Research. Employment growth is also stagnating, a worrying sign for household finances and domestic consumption.
Traders believe the ECB will see reason and embark on a raft of cuts. They are betting on euro zone interest rates being 2.5% by next June from 3.75% now, according to derivatives prices collected by LSEG. By then, the ECB expects inflation of 2.2% and annual GDP growth of 1.4% - a textbook “soft landing”. To get there, though, Lagarde will have to give more thrust to the economy with lower rates.
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CONTEXT NEWS
The German ZEW economic sentiment indicator fell to 19 in August from 42 in July, the ZEW economic research institute said on Aug. 13.
The metric measures financial-markets participants’ expectations for key international economies. The participants include about 350 economic analysts from banks, insurance companies and large industrial corporations. Most of the analysts are from Germany.
Traders are betting on a series of ECB rate cuts Traders are betting on a series of ECB rate cuts https://reut.rs/4dnZup7
Editing by Liam Proud and Streisand Neto
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