The ECB to drop a big hint about interest rates this week, economists say

After the first cut in five years, the European Central Bank (ECB) has given mixed signals about what it plans to do next, but economists say that could change later this week.

The ECB’s Governing Council will hold its next meeting on July 18, where officials are expected to keep interest rates on hold. But there's more at stake.

According to Bloomberg’s senior euro-area economist, David Powell, the real story will be whether ECB President Christine Lagarde drops a hint about a September rate cut.

“The ECB’s July 18 meeting will be closely watched by investors to fine-tune their expectations for the timing of the next rate reduction, even though it’s almost certain to leave rates unchanged this month," Powell said.

"Lagarde is likely to hint at another move in September, without being too committal.”

Lagarde’s commentary will carry extra weight because the Governing Council won’t meet again for another eight weeks. As Bloomberg reported, that’s the ECB’s longest stretch between meetings since the height of Covid in 2020.

No ordinary rate cut

The June cut was met with a lot of criticism because, although signaled in advance, it came at a time when inflation was picking up.

Ironically, ECB officials themselves ramped up their inflation forecasts while voting to slash interest rates. For many economists, that was a huge red flag.

“They cornered themselves,” former ECB official Dirk Schumacher said. It seems like they “almost boxed themselves into a bit of a corner” with the decision to cut, added Rob Burrows, a portfolio manager at M&G Investments.

Eurozone inflation moderated to a 2.4% annual rate in March and April before accelerating slightly to 2.6% in May. Last month, it fell back to 2.5%, but service prices—a major pain point for the ECB—soared to 4.1%.

“We still have questions about services inflation,” ECB chief economist Philip Lane told Bloomberg. “These data do not settle that. We need some additional time.”

Although service prices remain stubbornly high, at least one ECB official believes the situation is not as dire as some policymakers are making it out to be.

Bank of Italy Governor Fabio Panetta, who sits on the ECB’s Governing Council, said service prices move differently than other inflation categories.

In his view, the central bank doesn't run the risk of reigniting inflation in services even with lower interest rates.

“Past key rate hikes are still squeezing demand, production, and inflation, and will continue to do so in the coming months,” Panetta said at the annual meeting of the country’s banking association in Rome.

“The reduction in key interest rates will continue at a gradual pace, accompanying the return of inflation to the target.”