j.P. Marín-Arrese | Headline inflation is markedly dropping in Europe, even if the core one trails behind. Plummeting energy costs have played a key role in reining in prices. Yet, the ongoing Middle East crisis could derail this process. Later this year, the unfolding of tax rebates to relieve consumers badly hit by the inflationary bout will feed fresh pressures. Thus, unless the ECB resolutely cuts rates in the October meeting, it may face mounting difficulties in scaling down the current restrictive stance. Lagarde now has a narrow window before potential headwinds trim her room of manoeuvre.
It’s time for Lagarde to seize this opportunity and cut rates. Even if inflation sees a slight uptick in the coming months, the European economy desperately needs a boost. The leading economies are struggling to break free from sluggish growth, and the risk of falling into recession still looms. Tight credit conditions wreak havoc on heavily indebted sectors and firms, trimming down investment. An accommodative monetary policy is crucial in securing a safer path forward. The current rates provide ample room for a substantial reduction, bringing them to neutral levels. The time for action is now to prevent further economic deterioration. The minimum cut investors discount in the October meeting seems a lukewarm response.
Some analysts claim the ECB should resist calls for softening its stance as long as prices do not converge on a lasting basis with their medium-term objective. This opinion grounds itself on the belief that monetary policy enjoys more firepower in combatting inflation than it does. Yet, it seems ill-equipped to cope with the supply-side inflation behind the current instability. As Christine Lagarde rightly pointed out, when resisting pressure to stiffen the ECB policy in 2021, raising rates won’t bring down gas prices. Maintaining high interest levels won’t bring inflation down while dampening recovery prospects.
As the Draghi report underlines, Europe badly needs to revamp its economy and increase investment. Loosening credit conditions would better contribute to that goal than raising vast amounts of money. Until the ECB unwinds its stringent monetary policy, any growth policy is bound to fail. Thus, Lagarde should not hesitate to slice rates significantly this week rather than delivering a meagre cut.
