The ECB’s fight against inflation: when will interest rates fall?

In the fight against inflation, the “last mile” could be the most difficult – that is, the final phase until the two percent inflation rate that the ECB is aiming for is reached. She already has the goal in mind.

At first glance, top-class sport and monetary policy don’t have much in common – but they do have one thing in common: it’s all about the right timing at the start. With regard to the central banks, the question arises as to when the interest rate screw will turn downwards again. The European Central Bank is already in the starting block, but is still hesitant to get going.

Carsten Mumm is sure that it will happen in the summer. He is the chief economist at the private bank Donner & Reuschel. “We firmly assume that we will see the first key interest rate cut by the ECB in June,” says Reuschel. “This has already been announced relatively clearly or at least promised by the central bank, by Christine Lagarde, the President of the ECB, and also by her colleagues.”

Stock markets are preparing for interest rate cuts

This expectation has already caused prices to rise on the stock market – because falling interest rates are likely to boost the economy. The result: The DAX continues to trade at record levels even though the German economy is fighting the recession. New data from the Federal Statistical Office strengthens the prospect of interest rates falling soon: Inflation weakened further in Germany in March. According to preliminary figures, it was 2.2 percent compared to the same month last year.

It is the lowest level in almost three years, and the inflation rate is therefore very close to the target of two percent. So why don’t the monetary authorities cut interest rates earlier, for example when they make their interest rate decision next week? Edgar Walk, chief economist at Metzler Asset Management, emphasizes the concern that the economy will recover too strongly – and a new surge in inflation will occur.

“It is therefore better to wait until June again, be sure that the downward trend in inflation continues, and then initiate a cycle of key interest rate cuts that can then last,” Walk explains the central bankers’ approach. “There is a great fear of making a mistake by cutting the key interest rate too early.”

Core inflation remains stubbornly high

This is also because some areas of inflation are still stubborn. This is reflected in core inflation. In March it was still 3.3 percent in Germany. Elements that are susceptible to fluctuations, such as food and energy, are excluded at this point. Recently, the drivers of core inflation have been the prices for services, says Mumm.

“If we think back two or three years, then we know that inflation started with exploding energy prices, raw material prices and supply chain bottlenecks,” said the economist. “In the next stage, goods and services rose very sharply. And the final stage we are now seeing is significantly rising wages, which ensures that service prices in particular continue to rise.”

Differences within the Eurozone

In addition, the ECB’s monetary authorities do not only have the Federal Republic in mind when making their decisions, even though Germany is the largest economy in the Eurozone. How the average rate developed in the 20 member states in March will be known on Wednesday. Countries like Croatia and Austria recently had to contend with inflation rates of more than four percent.

However, economist Walk assumes that the downward trend in inflation will also be confirmed with a view to the monetary community. “We have been seeing that inflation in the euro zone is falling for several months now. We expect it to continue to fall and that we will soon have inflation rates of less than two percent,” he predicts.

“Accordingly, there is an expectation that the ECB will cut key interest rates not only in June, but also in the meetings thereafter.” It is not yet possible to say with certainty how low interest rates in the Eurozone could fall over the course of the year. One thing is already clear: for the central banks, fighting inflation is anything but a sprint – it remains a constant race.