ECB: balancing interest rates amidst geopolitical strains

The European Central Bank (ECB) is gearing up to make a crucial decision that could have significant repercussions on the European economy. On Thursday, for the first time in over a year, the ECB could decide to keep interest rates unchanged, in an already challenging economic climate in Europe, further exacerbated by the war between Israel and Hamas.

After an incessant series of 10 consecutive rate hikes starting from July 2022, which brought the key rate to a record high of 4%, the ECB now seems ready to follow the example of other central banks, such as the US Federal Reserve and the Bank of England. These institutions have chosen to keep borrowing costs stable, despite being at the highest levels in recent years, thanks to a slowdown in inflation.

Europe experienced moments of tension when inflation reached a peak of 10.6% in October, due to the repercussions of the war in Ukraine. This high inflation had a negative impact on consumption, putting a strain on households’ finances with additional costs for essential goods such as food, heating, and electricity. However, with inflation now reduced to 4.3%, analysts predict that the ECB will avoid further rate hikes during its upcoming meeting in Athens, one of its usual sessions outside its main headquarters in Frankfurt, emphasizing its role as an institution of the European Union.

But the concerns don’t end there. Economic indicators show signs of a slowdown, and there is fear of a possible recession. Rate hikes are the main tool of central banks to combat inflation, but they can also hinder economic growth by making credit more expensive for consumers and businesses.

ECB: economic indicators and signs of a slowdown

Recent surveys conducted by S&P Global suggest a decline in economic activity in October. ABN Amro analysts predict a contraction of 0.1% in the eurozone GDP for the July-September quarter and 0.2% for the last three months of the year. The EU will release third-quarter data on Tuesday.

Inflation has heavily impacted consumers, to the extent that Europe has recorded a growth of only 0.1% in the first two quarters of this year. Germany, the largest European economy, could see a contraction of 0.5% this year, becoming the worst-performing economy among major ones worldwide. Even Russia, despite its challenges, is expected to experience growth.

Another cause for concern is the war in the Middle East, which could influence oil prices. Although there hasn’t been a significant increase in prices or a disruption in supplies yet, Europe, heavily reliant on imported energy, could be affected by any developments in the conflict.

Carsten Brzeski, Global Head of Macroeconomics at ING, stated, “The ECB will not be in a hurry to intervene. It will prefer to wait for further data on the delayed impact of rate hikes and the trends in oil prices.”

Attention is now shifting to the duration of these record-low rates. ECB President Christine Lagarde has reiterated the bank’s message that rates have now “reached levels that, if maintained for a sufficiently long period, will significantly contribute to the return of inflation” to its target of 2%, considered optimal for the economy.