The European Central Bank’s hesitation to cut rates before further signs of slowing wage growth reflects a “hawkish bias” that could lead to weak growth becoming entrenched across the eurozone economy, the head of a leading European think tank warned on Wednesday (27 March).

Jeromin Zettelmeyer, director at influential EU policy think tank Bruegel, stressed that the ECB is facing a “delicate balancing act” between ensuring that wage increases do not trigger an inflationary resurgence and averting the risk that its restrictive policy unduly damages Europe’s “very weak economy”.

However, Zettelmeyer noted that the ECB’s decision to wait for further wage data — even though the bloc’s annual wage growth slid from 5.1% to 4.6% in the final quarter last year — puts excessive emphasis on inflationary headwinds and by doing so threatens to trap the eurozone economy in a scenario of “secular stagnation”, or long-term low growth.

“The ECB actually wants to see evidence of slowing wage growth before it eases [rates],” Zettelmeyer told an event hosted by the Centre for European Reform, another Brussels-based think tank.

While the central bank has one data point suggesting wage growth is falling, Zettelmeyer said it does not consider it enough and “wants to see another one”.

“I would interpret this as reflecting quite a conservative bias, quite a hawkish bias… The ECB insists on seeing evidence two times in a row that actually real wage slowing is the plausible assumption,” he said.

“And that means that in trading off these two evils of easing [rates] prematurely or getting into the secular stagnation world, I think it’s putting a lot of weight on the risk that inflation may rise again.”

The ECB hiked interest rates on ten consecutive occasions from July 2022 to September 2023 — bringing its key interest rate from negative levels to a record high 4% — after prices soared following Russia’s full-scale invasion of Ukraine in February 2022.

Inflation has since fallen from a peak of 10.6% in October 2022 to 2.6% in February, just decimal points above the bank’s 2% target rate. The bank currently expects inflation to fall to its 2% target next year, before dropping to 1.9% in 2026.

The ECB has held rates steady at its four previous meetings, the latest of which took place earlier this month.

With the ECB’s Director General for Economics, Oscar Arce, conceding earlier this month that the bank’s monetary policy would have a negative impact on eurozone growth until 2026, the institution’s tight stance has come under increased criticism.

Many analysts argue that lower rates are necessary to boost the bloc’s dwindling growth and stimulate the investments required to facilitate the green and digital transitions.

At its most recent meeting, the ECB itself slashed its 2024 growth forecast for the eurozone from 0.8% to 0.6%.

Weak growth has been especially pronounced in Germany, the eurozone’s largest economy but also the world’s worst performing one last year, when it contracted by 0.3%.

This morning, the country’s five leading economic institutes slashed their forecast for German GDP growth to 0.1% in 2024, down from their previous projection of 1.2%.

Clock ticking

Zettelmeyer was responding to comments posted at the same event by Piero Cipollone, a member of the ECB’s executive board, who hinted at future rate cuts without committing to a more specific timeline.

“The improving inflation outlook, continued strong transmission and further moderation in inflation all create scope for more confidence that we can dial back restriction,” Cipollone said. “We are coming close to the point when we will have the confidence to act.”

Cipollone also noted that although “concerns about unit labour costs need to be taken seriously”, there are nevertheless “grounds to argue that the current economic environment allows a recovery in real wages in the short-term that will not fuel inflation”.

Echoing previous comments by ECB President Christine Lagarde and other senior ECB officials, Cipollone said the easing of supply shocks, as well as profits’ declining contribution to inflation, mean that “firms [can] absorb wage pressure such that they are not passed onto consumer prices”.

Analysts currently expect the ECB to begin cutting rates in June — a prediction Lagarde herself has repeatedly corroborated in recent months.

In January, Lagarde said that although rate cuts will “likely” be introduced by the summer, crucial wage bargaining data used by the ECB to determine monetary policy will only be available in “late spring”.

The ECB chief reiterated these comments on Wednesday (20 March) last week.

“We will receive data on negotiated wage growth in the first quarter of this year at the end of May,” she said, adding: “By June, we will have a new set of projections that will confirm whether the inflation path we foresaw in our March forecast remains valid.”

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German economy to nearly flatline this year, Kiel, ifo Institutes say

Frankfurt, Germany, March 27, 2024 (AFP) — The German economy is expected to barely grow this year, leading economic institutes said Wednesday, as weak demand at home and abroad slows the path to recovery.

Europe’s largest economy will expand by just 0.1 percent in 2024, five think-tanks said in a joint statement, a sharp downgrade from their earlier forecast of 1.3 percent growth.

"Cyclical and structural factors are overlapping in the sluggish overall economic development," said Stefan Kooths from the Kiel Institute for the World Economy (IfW Kiel).

"Although a recovery is likely to set in from the spring, the overall momentum will not be too strong," he added.

The German economy shrank by 0.3 percent last year, battered by inflation, high interest rates and cooling exports, and is struggling to emerge from the doldrums.

Even though inflation has steadily dropped in recent months, consumer spending was picking up "later and less dynamically" than previously forecast as wages lag behind, the institutes (DIW, Ifo, IfW Kiel, IWH and RWI) said.

And Germany’s export sector, usually a key driver of economic growth, was suffering from cooling foreign trade against a fragile global economic backdrop.

Energy-intensive businesses in particular have been hit hard by soaring energy prices following Russia’s war in Ukraine, contributing to a manufacturing slump in Europe’s industrial powerhouse.

Corporate investments meanwhile have been dampened not just by the European Central Bank’s interest rate rises, which have made borrowing more expensive, but also by "uncertainty about economic policy", the institutes said.

- Debt brake debate -

The criticism of Berlin comes after a shock legal ruling late last year threw Chancellor Olaf Scholz’s budget into disarray, forcing the government to rethink its spending plans.

The government recently also drastically downgraded its own economic forecasts, expecting output to expand by just 0.2 percent this year.

Economy Minister Robert Habeck last month acknowledged the economy was "in rough waters" and in need of a "reform booster".

But Scholz’s three-way coalition government -- made up of the Social Democrats, the Greens and the liberal FDP -- is divided over how to turn the tide.

Calls have grown for the government to relax its constitutionally enshrined "debt brake", a self-imposed cap on annual borrowing, in order to turbocharge much-needed spending on infrastructure modernisation and the green transition.

Habeck is in favour of relaxing the debt rules, but Finance Minister Christian Lindner from the FDP is deeply opposed.

The think-tanks said they recommended "a mild reform" of the debt brake to allow "for more debt-financed investments than before".

Looking ahead, the institutes expect the recovery to quicken next year as inflation eases further and demand picks up.

They now expect the economy to grow by 1.4 percent in 2025, only slightly below their previous forecast of 1.5 percent.