Photo: Paula Čurkste/LETA
Mārtiņš Kazāks, President of the Bank of Latvia.
The Council of the European Central Bank (ECB) will soon start reducing interest rates, writes Mārtiņš Kazāks, president of the Bank of Latvia and member of the ECB Council, on the website “Makrokenomika.lv”.
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Last week, the Governing Council of the ECB discussed the forecasts of the economic development of the Eurozone and decided to leave the euro interest rates unchanged at the level of 4%.
Kazak points out that inflation in the eurozone is becoming slower and closer to the 2% target. At the same time, the weakness in the economy has dragged on, and we will not see rapid growth this year either. Although there is some slack in the labor market, the labor market remains strong and unemployment is at historically low levels, while wage growth is outpacing price growth and the purchasing power of citizens is gradually recovering from the shock of inflation.
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In February, inflation in the Eurozone fell to 2.6%, but in Latvia it was only 0.6%, notes Kazāks. Natural gas prices at the beginning of the year are significantly lower than forecast, and are one of the reasons why the inflation forecast for the Eurozone was lowered to 2.3% this year. This means that already in the second half of the year, inflation in the Eurozone could approach 2%. The forecast for 2025 and 2026 is 2% and 1.9%, respectively. If the forecast comes true, then the inflation target – symmetrically around 2% in the eurozone in the medium term – will be reached in about three years, which is an acceptable period of time for the medium term, Kazaks explains.
The President of the Bank of Latvia reminds that inflation will rise above the 2% target in 2021. Last year, the eurozone economy was on the verge of recession, it is still weak, and this year the growth of the gross domestic product is predicted to be only 0.6%, but in 2025 and 2026 it will be a little faster, namely 1.5% and 1.6%.
Kazak explains that the main drivers for the growth of the Eurozone economy are stronger growth in the world economy, which will boost Eurozone exports, wage growth faster than inflation, which will boost household consumption, as well as a gradual reduction in interest rates, which will boost investment and consumption.
“However, risks and uncertainty remain high. If for inflation, in my opinion, these risks are balanced, then for economic growth they are downward, that is, slower growth is more likely than faster growth,” says Kazaks.
Although the ECB Council did not discuss the reduction of interest rates already at the March meeting, a discussion was started on a possible rate reduction in the future, informs Kazaks. If until recently the risk of reducing interest rates too quickly and thus driving inflation rates up again, which would require rate hikes well above the current 4% to slow down inflation, was much greater than the risk of starting to reduce rates too late, then, in Kazak’s view, these risks are now beginning to level out and over there is no need to delay the reduction of rates.
If the economy will roughly follow the forecast scenario outlined above, then the decision to start reducing interest rates could be taken already within the next few meetings, predicts Kazaks. The financial markets currently have a rather similar vision, fully pricing in the first rate cut by 0.25 percentage points already in June.
Inflation grew very rapidly, and it has also decreased rapidly, Kazak admits. The goal of the Governing Council of the ECB is to return inflation to 2% and prevent it from rising again. Kazak emphasizes that uncertainty remains high, so some caution is still necessary.
One of the reasons for this year’s lower than previously forecasted inflation is natural gas prices, Kazaks explains. With the current unexpectedly low natural gas prices rising, inflation would rise again. The tension in the labor market is still high – although the rates of wage growth have slowed down, they are fast and create risks for inflation to be “stubborn” and to decline very reluctantly.
“Therefore, as before, we will base our decision-making in the ECB Council on a cool mind and current data. The dragon of inflation has been forced to the ground, a little more and it will be defeated,” Kazak writes.
It has already been reported that on March 7, the European Central Bank decided to keep interest rates unchanged for the fourth time in a row. At the meeting of the ECB Council in Frankfurt, it was decided to maintain the main refinancing operations rate at 4.5%, the overnight deposit rate at 4% and the overnight lending rate at 4.75%. In order to fight against inflation, interest rates had previously been increased by the ECB Council for ten meetings in a row.
2024-03-13 11:12:04
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