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Can ECB go ahead with rate cuts? Researchers say yes

The research argued that a percentage point of lost economic production would have resulted from the ECB tightening policy earlier, which would have allowed inflation to peak at just 6%

Two academics will report to the ECB’s top brass in July 2024 to inform them that the bank can continue to gradually lower interest rates and confront an “easy last kilometre” in its battle against inflation.

Using a model that breaks down inflation into supply, demand, and the impact of monetary policy on the latter, the researchers Giorgio Primiceri and Domenico Giannone concluded that, barring any fresh shocks, inflation was returning to the ECB’s 2% target.

Primiceri and Giannone concluded their research with the following: “This analysis implies that there are reasons to be hopeful about inflation, both in the immediate and the more distant future. In fact, according to our estimate, the upcoming quarters should see an easy last kilometre.”

Following a significant decline in energy costs that helped push inflation down from its 10% peak in late 2022 to 2.6% in May 2024, ECB board member Isabel Schnabel has been cautioning that “the last mile of disinflation” would be “the most challenging.”

However, the study projects that even with the policy rate being lowered from its current 3.75% to 2.5% starting 2025, inflation will still be below the ECB’s target through 2026. This aligns with the expectations of the market.

Contrary to popular belief, Philip Lane, chief economist at the European Central Bank, reaffirmed that the authors found that a stronger-than-anticipated rebound in demand following the COVID-19 pandemic rather than a limited supply was the primary cause of the high inflation in 2021–2022.

The research argued that a percentage point of lost economic production would have resulted from the ECB tightening policy earlier, which would have allowed inflation to peak at just 6%.

The authors stated, “Since severe supply conditions were already straining economic activity, such action has probably helped avoid a considerable further decrease in economic activity.”

Meanwhile, a fresh European Central Bank survey has found that Eurozone consumers continued to cut their inflation expectations and also grew more optimistic about employment prospects even as they still saw economic contraction ahead.

Consumer views on inflation have not been vastly different than that of the analysts and economists, as they cut their expectation for price growth for 2025 to 2.8% in May from 2.9% a month earlier, and reduced their projection for three years ahead to 2.3% from 2.4%.

Economic growth expectations for the next 12 months remained unchanged at minus 0.8% while expectations for the unemployment rate decreased to 10.7% from 10.9%, the ECB’s Consumer Expectations Survey showed further.

The ECB cut interest rates from record highs early in June 2024 and signalled further moves ahead as inflation eases. However, it did not commit to the timing of its next cut and policymaker commentary suggests that a step will not even be considered before September, at the earliest.

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