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HomeTop Business NewsJim Power: ECB Rate Hike Campaign Should Take a Sensible Pause

Jim Power: ECB Rate Hike Campaign Should Take a Sensible Pause


On September 14, the Governing Council of the European Central Bank (ECB) will convene to make decisions regarding future interest rate policies. While central bank actions are often unpredictable, there is currently a high level of uncertainty surrounding the upcoming meeting. This uncertainty arises from the fact that a significant amount of tightening has already been implemented, with a time lag for the full effects of rate increases to take effect and achieve the desired objective of bringing inflation back to its 2% target.

In July, the ECB raised rates by 0.25%, bringing the cumulative total increase since July of the previous year to 4.25%. This rate tightening has occurred at a rapid pace, which is unusual when compared to historical standards. There is now a growing sense that the ECB may have done enough, but it is difficult to say for certain as central bankers sometimes overcompensate both on the way up and on the way down. Central banking, like economic forecasting, is far from an exact science.

In the statement following the July increase, the ECB stated that interest rates would be set at “sufficiently restrictive levels for as long as necessary.” This represents a subtle but significant change in language from the previous meeting, where the ECB had stated that interest rates would be brought to levels “sufficiently restrictive” to bring inflation down to the 2% target. This change in language suggests that the ECB may believe it has done enough, but remains uncertain.

While global economic data has been mixed and confusing over the past year, there are clear indications that economic growth and inflationary pressures in the eurozone are diminishing. Headline inflation in July decreased to 5.3%, which is still significantly above the desired 2% target, but it has dropped from a peak of 10.6% in October of the previous year. However, much of this decline can be attributed to decreases in oil and gas prices. Core inflation, which excludes energy, food, tobacco, and alcohol, remains high at 5.5%.

Of particular concern is the inflation rate of 5.6% in the services sector. This is consistent with the situation in Ireland, where service sector inflation is at 10%, while goods inflation stands at just 0.6%. Inflation in the services sector across the eurozone, as well as in the United States, is primarily driven by tight labor markets. In Ireland, the unemployment rate is near a historic low of 4.1%, while in the eurozone it stands at 6.4%, the lowest since the creation of the euro in 1999. The ECB would prefer to see unemployment rise, considering it a worthwhile price to pay in order to regain control over inflation.

Other indicators of economic activity in the eurozone suggest weakness, particularly in the manufacturing sector, which is crucial for Germany. The Purchasing Managers Index (PMI) for manufacturing is at 42.7, indicating a contraction, while the PMI for services is at 50.9, suggesting a slight expansion. These indices are constructed based on the premise that a reading above 50 signifies expansion, while a reading below 50 indicates contraction. Manufacturing is clearly experiencing significant challenges, while service sector activity is also trending weaker.

GDP growth in the eurozone declined by 0.1% in the final quarter of 2023, remained flat in the first quarter of 2023, and expanded by 0.3% in the second quarter. These figures indicate an economy that is stagnating, with inflation gradually moving towards its target. Given these circumstances, it would be wise for the ECB to halt its rate tightening and observe how the past year’s increases work through the system.

In the meantime, Irish banks will continue to benefit from substantial net interest margins at the expense of the deposit base. The response of Irish banks when the ECB begins to loosen monetary policy can only be speculated upon.

Thomas Lyons
Thomas Lyons
Thomas, the founder and chief editor at Top Rated, harbours a deep-seated passion for business, news, and product reviews. His thirst for knowledge and experience has led him on a journey across the length and breadth of the country, enabling him to garner a wealth of insight. At TopRated.ie, his sole aim is to deliver meticulously researched news and provide impartial reviews of fact checked Irish companies, thus helping readers make well-informed decisions.


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