The European Central Bank’s (ECB) decision to cut interest rates in June was not only perplexing but also premature. This was underscored by the ECB’s decision in July to maintain the rates at their new level, despite economic conditions remaining largely unchanged. This confirms my earlier assertion that the June rate cut was unnecessary and, frankly, bizarre.
The June rate cut did not reflect the economic reality. Inflation remained high, and the economy had not shown significant signs of improvement. The ECB’s decision, therefore, seemed hasty and ill-considered, jeopardizing the bank’s credibility. Delaying the cut until September would have been more prudent and would have had no significant impact on the broader economic picture. The Federal Reserve, in contrast, has demonstrated more judicious restraint in its policy adjustments.
In the July press conference, ECB President Christine Lagarde emphasized a commitment to data-dependent decision-making. However, this stance appears implausible following the June cut, which contradicted the ECB’s own criteria for reducing rates. Inflation had risen, estimates remained high, and labor costs were accelerating—a trifecta of red flags the ECB had previously indicated would preclude a rate cut.
Lagarde downplayed rising labor costs, attributing them to a catch-up effect from past inflation. While some catch-up may be occurring, the primary driver is a tight labor market and eroding confidence in the ECB. The bank’s inaction during the initial inflation surge has undermined trust, including among trade unions.
After two decades of pledging to maintain low inflation, the ECB’s failure to act decisively during the recent inflation spike has had lasting repercussions. Lagarde’s dismissal of wage growth concerns as “not unexpected” and her projection of slower growth in 2025 and 2026 seem more like wishful thinking than strategic planning. It’s akin to hoping for the best rather than enacting sound policy.
Lagarde’s assertion that inflation will remain high into 2025, coupled with the promise to maintain current interest rates, may sound resolute. In reality, it highlights the ECB’s ongoing failure to fulfill its primary mandate. The threat to keep rates steady in such an environment, while simultaneously hinting at further cuts, is indicative of poor management.
The International Monetary Fund (IMF) recently warned that early rate cuts could exacerbate inflation, especially given persistent inflation in the services sector and geopolitical pressures. The IMF’s cautionary advice seems to have fallen on deaf ears in Frankfurt, where rate hikes have become a verbum non grata.
Considering the ECB’s inflation outlook, it wouldn’t be surprising if the target date for achieving desired inflation rates gets postponed to 2027. Originally projected for 2024, the goalpost has continually shifted, reflecting a strategy that is failing to meet its objectives.
Lagarde announced that the ECB will soon review its monetary strategy introduced in 2021. Allow me to preemptively critique this strategy: it has been a series of missteps leading to repeated failures. The latest ECB research, revealing that different households experience inflation differently and that sustained inflation increases inequality, underscores the bank’s disconnect from practical realities.
The ECB’s current trajectory raises serious questions about its policy framework and strategic direction. Without significant course corrections, the bank risks further erosion of its credibility and effectiveness.
Edin Mujagić is an economist, manager of Hoofbosch Investment Fund, and author of “Turning Point 1971”. He provides monthly insights on ECB monetary policy for the Financial Times.