The European central bank (ECB) may be facing another rate cut, after initiating the start of a new easing cycle in June. At their meeting on 12. September is expected, that the ECB will raise interest rates further 25 base points lowered. Given the similar signals from the US Federal Reserve, this step could be easier for the ECB members. But as soon as interest rates drop to about 3 % sink, The ECB's decisions are likely to become increasingly controversial. This suggests so, that heated discussions could arise about it, how best to keep inflation under control.
The search for the optimal interest rate
During the next two to three interest rate cuts from currently 3,75 % is unlikely to cause major disagreements among the ECB members, the discussions could become more intense, as soon as interest rates rise 3 % sink. Different views on the price outlook and the point, at which monetary policy should no longer slow down economic growth, could lead to heated debates.
Estimates for this critical point range from 2 % to 3 %. With inflation falling, markets and analysts expect, that interest rates could move closer to the upper end of this range by the end of the year. Many people expect it, that they finally settle at about 2,5 % will settle down.
Early signs of tension
Isabel Schnabel, Member of the ECB Executive Board, warned recently: “The closer interest rates get to the upper range of estimates of the neutral interest rate, the more careful we should be, to avoid, that monetary policy itself becomes a factor, which slows down disinflation.”
Room for interest rate cuts
The ECB representatives largely agree, that there is still room for further interest rate cuts, as consumer price increases are still in line with the forecast, that the 2% target could be achieved by the end of next year. After the first rate cut in June, further cuts are expected in September and December, and an additional reduction in October cannot be ruled out.
Disagreement about inflation
The opinion about it, how strong inflation is currently 2,2 % – could continue to rise, is split. While some members of the ECB fear, that easing monetary policy too quickly could fuel inflation, others are worried about the possibility of missing the inflation target, especially given the weakening economy in the Eurozone.
Statements from ECB members
Greece's Yannis Stournaras stressed the need, both about- as well as undershooting the inflation target. Portugal's Mario Centeno warned against this, that too restrictive monetary policy could cause economic pain. In contrast, Boris Vujcic from Croatia highlighted continued price growth in the services sector, while Bundesbank President Joachim Nagel warned against cutting interest rates too quickly.
The question, when monetary policy begins, to stimulate economic growth instead of slowing it down, remains controversial. The so-called neutral interest rate is difficult to determine, and estimates vary considerably.
A look at the different assessments
Some ECB economists estimate the neutral interest rate to be in a range of 1,25 % to 3 %, while others, like the French economic expert Francois Villeroy de Galhau, an area of 2 % to 2,5 % to name. This suggests so, that there is still considerable scope for interest rate cuts, before monetary policy could be viewed as restrictive.
A divided committee
The risk of stagflation in the euro area will make discussions about further interest rate cuts increasingly controversial. The Governing Council is strongly divided between the “doves”, who prefer a loose monetary policy, and the “Falcon”, which require a cautious approach. As ING’s Carsten Brzeski notes, the hawks will be more willing to cut interest rates, if economic growth in the euro area continues to weaken.