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“ECB failed to clearly communicate the need to cut interest rates this year”

Statement of January 25, 2024

DIW president Marcel Fratzscher on the results of today's meeting of the Governing Council of the ECB:

BlockquoteThe ECB's decision not to cut the key interest rate yet is understandable and correct at this point in time. However, I would have liked to see clearer communication from the ECB pointing out the need to cut interest rates this year. It would have been helpful to signal a change in the interest rate cycle and the need for rate cuts in order not to jeopardize the goal of price stability in the medium term by pushing inflation below two percent.

Such forward guidance would have been important in order to improve financing conditions. After all, monetary policy is the biggest brake on economic growth in the euro area this year, especially for Germany. The German economy is unlikely to grow much this year and many companies are holding back on investment as financing conditions are very restrictive. This applies in particular to the construction sector, but also to many industrial sectors.

The risk of the ECB "undershooting" the two percent inflation objective in the next two years is now just as great as inflation remaining too high. Overall, inflation in the euro area has fallen faster than expected in recent months. Both the weaker economic development and the significant fall in energy prices are two of the main reasons.

The ECB is facing some very difficult years with strongly fluctuating inflation. This is because it is likely that geopolitical conflicts, problems in supply chains and adjustments in relative prices will repeatedly lead to temporary shocks to inflation. Wage trends are also likely to be very dynamic over the next two to three years, as employees will want to compensate for the considerable real wage losses they suffered in recent years. However, such an adjustment need not be problematic, especially as a sustained wage-price spiral is unlikely. The ECB must look through such temporary shocks and keep a closer eye on the medium and longer term.

Topics: Monetary policy