Inflation in the Euro Area is mainly within the ECB’s target, and the economy is growing modestly. That’s usually the recipe for the central bank to sit back and refrain from making any monetary policy changes. That seems to be the attitude of the ECB, after President Christine Lagarde largely avoided discussing monetary policy in her Jackson Hole speech last week.
So, does that mean we can ignore the data under the assumption that no significant changes are coming? Not really. There is still a lingering debate within the ECB itself about whether a further 25bps cut is warranted. However, the data could also easily shock the ECB out of its current stance and force it to change its policy. That’s particularly true in this uncertain environment, when it’s still unclear what effects the US tariffs will have on consumer prices.
Growth vs Prices
Now that the pandemic-era inflation has been addressed, the ECB returns to its decades-long challenge. Slow economic growth in Europe has meant sluggish organic inflation. This has compelled the ECB to lower rates in the past, even to negative levels. The bank must look to the medium and long term to achieve price stability. Even if inflation is currently at the right level, it can’t let its guard down regarding the future of low price growth amid slow growth.
Which means that inflation measures are still important, but so is GDP. If the European economy doesn’t pick up, then internal price pressures might drop. This is, at least, the argument of the still dovish members of the central bank, who are still arguing that rates need to be trimmed at least another quarter point.
The Deciding Factor
Consumer behaviour is not even across Europe, and that can influence monetary policy. This is the “fragmentation” that Lagarde often refers to, but since it usually doesn’t have an immediate impact on the next rate decision, the markets largely ignore it. However, with Germany running an inflation rate twice that of France, fragmentation could become a significant issue.
For Germany, easing interest rates might be problematic, as it would push inflation above target. However, France may require further easing to support its economy and maintain price stability. These differences can be seen in the ECB, where the allocation of votes is not proportional to the population. Germany has only one vote in the MPC but 16 times the population of Ireland. On the other hand, Ireland has a lower inflation rate than Germany, and it has an equal voting power at the ECB when it comes to cutting rates.
What to Look Out For
If inflation starts to slip back below the ECB’s target, the talk of cutting rates again could intensify. This could further weaken the Euro, which has been falling behind as stronger US growth has shifted investor interest during the summer. The difference in rates between Germany and France could come into increased focus.
On Friday, French flash August inflation is expected to tick up to 1.1% from 1.0% in the previous month. A couple of hours later, German inflation is expected to tick up to 2.1% from 2.0% in June. Then on Tuesday, Euro Area flash August inflation is expected to rise to 2.1% from 2.0%. The core rate is also seen rising to 2.4% from 2.3%.