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European Central Bank set to hold rates with inflation picture muddying demand for cuts - CNBC
KEY POINTS
- A rate hold would come amid uncertainty about underlying inflation dynamics, especially stemming from the labor market.
- Recent inflation data showed a decline in headline inflation but wage growth is a still serious headache for the ECB.
FRANKFURT — The European Central Bank is set to keep interest rates steady this week after cutting in June for the first time since September 2019.
The hold would come amid uncertainty about underlying inflation dynamics, especially stemming from the labor market, which have weighed on the central bank’s resolve to embark on a rapid path of cuts.
“ECB speakers, including President [Christine] Lagarde and Chief Economist [Philip] Lane, have made it quite clear that the July meeting is set to be more of a stock-taking exercise than a policy-decision meeting, also given the absence of new staff forecasts,” Anatoli Annenkov of Societe Generale said in a recent research note.
“With no new quarterly data available, e.g. GDP, compensation and labour productivity data, the [ECB’s] Governing Council will instead have to make do with mostly survey data,” he said, adding that previous data points to a bumpy recovery in the euro area — the 20 countries that share the single currency.
A Purchasing Managers’ Index from early July showed that the manufacturing industries slumped back to a contraction. Also the widely regarded ZEW Index for Germany posted a bigger decline than expected with the outlook for businesses deteriorating.
But while the economic trajectory seems uncertain and biased to the downside, the inflationary picture is still not clear. Recent inflation data showed a decline in headline inflation but wage growth is a still serious headache for the ECB.
“Given that the disinflation on the back of lower energy prices and normalization of supply chains has mostly run its course, wage growth has now evolved into the main stumbling block for the ECB to reach its 2% inflation target,” said Dirk Schumacher, an ECB watcher at Natixis, in a recent research note to clients.
We’re in unchartered territory for the ECB as it needs to set policy amid heightened uncertainty from geopolitics, but also specific political fronts such as election results in France and the upcoming U.S. vote.
“We still expect headline inflation to fall closer to the target in September and October, suggesting that a September cut could be well timed. Beyond that, things are less clear. The ECB will want to see a material slowdown in wage growth before year end,” Annenkov said.