The European Central Bank (ECB) has, as widely predicted, cut European interest rates to 3.75%. But policymakers are now expected to hit the pause button as sticky inflation is a worry.
Financial markets are only fully pricing in two rate cuts by the ECB by the end of the year and its looking unlikely that there will be another cut next month.
But what does this mean for the economy and what’s next in 2024?
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On the road to recovery?
The Eurozone’s in the recovery stage. Growth has risen by 0.3% in the first three months of the year after six quarters of stagnation and contraction.
Unlike previous economic rough patches, companies have kept on their staff – with unemployment now at an all-time low.
This means stubborn pay growth remains a concern for policymakers following rises in negotiated salaries.
Headline inflation went in the wrong direction at the last count, heading away from the ECB’s 2% target. It rose by 2.6% year-on-year in May, compared to 2.4% for the previous two months, a larger increase than expected.
Prices in the services sector, normally a good indicator of domestic demand, jumped to 4.1% from 3.7%.
If pay growth continues its path, there are concerns that it will feed further into higher prices, which is why policymakers are expected to stay more cautious in the months ahead.
If higher borrowing costs continue – this is set to have a further knock-on effect on the bloc’s economy, which is only just on the mend.
Unemployment‘s forecast to rise, which could help ease pay pressures but cause a fresh reduction in economic activity.
Even if interest rates creep down again later this year, it won’t stop further problems for the commercial property market, like office space or supermarkets, given the jump in refinancing costs.
The deficit risk
The international monetary fund has warned that Europe’s lacklustre growth prospects risk causing economic instability.
On the face of it European economies are constrained by growing deficits and strict rules on borrowing. They need to borrow to spend big on boosting fragile economies.
This is especially true with increasing demands on budgets from the increased military spending and supporting the green transition to meet agreed climate targets.
11 countries including France, Italy and Belgium had deficits last year above 3% of GDP, the official high limit for debt.
But there could be some wiggle room with new rules that give a four-year grace period, with an option of extending to seven years – if governments show they’re making investments aimed at boosting growth in the economy.
Policymakers must now walk the tightrope between future interest rate cuts and borrowing to balance the books and kickstart growth.
