The landmark 0.25 percentage point cut in euro bloc interest rates caps an extraordinary period when the European Central Bank has coped much better than expected in mitigating strains on its 26-member governing council.
Christine Lagarde, ECB president, has managed to steer a middle path between steadfastness in the anti-inflation fight and sensitivity towards central bank governors chafing over the 0.25-point rise in the key deposit rate in September 2023, which an important minority on the council thought was unnecessary.
Announcing the cut on 6 June, the first for five years, Lagarde pointed to the need for prudence in coming months in view of continued upward wage pressures and a headline inflation rate still above the 2% target. The bank said it was ‘now appropriate to moderate the degree of monetary policy restriction’ after a 2.5-point fall in inflation since the September hike.
Although the ECB said it was not ‘pre-committing’ to further interest rate reductions, leading figures on the council have spoken in favour of quarterly rate cuts over the rest of the year. There is a significant belief that above-average wage rises do not indicate any danger of a wage-price spiral. Rather they are seen as a normal catch-up reaction to sharp falls in real wages in the euro area throughout the past few years’ inflationary spell.
The ECB is aware of potential vulnerability in moving relatively fast on rates in the current easing cycle, ahead of the Federal Reserve and Bank of England. However, these risks are felt to be manageable in view of the fragile state of large parts of the euro bloc economy, especially Germany. In view of the Bank of Canada’s 0.25 point rate cut on 5 June, as well as reductions in Switzerland and Sweden since March, the ECB can be viewed as occupying the rate-cutting middle ground among a wider group of leading central banks.
The controversial interest rate rise in September was pushed through following a decisive intervention by Joachim Nagel, the Bundesbank president, who has forged a strong strategic bond with Lagarde since taking over in January 2022. The September rise is now termed an ‘insurance’ hike guarding against the risk that internal and external price pressures could have accelerated during the winter. This eventuality turned out not to materialise. Yet Nagel can be expected to garner credit in managing to push through the rise and stiffen ECB resistance to any slackening of the restrictive stance in the last few months.
Lagarde has spoken out against formal ‘forward guidance’ on interest rates and insisted on adherence to a ‘meeting by meeting’ assessment of the economic and monetary position. However, the ECB’s reduction represents vindication of the position she has maintained for several months that rate cuts were not likely before June.
On his appointment in December 2021 Nagel was enjoined by his backers in the German finance ministry both to help forge a tight ECB monetary policy and to overcome the Bundesbank’s previous frequent isolation in the council. Nagel’s predecessor Jens Weidmann, now president of the supervisory board of Commerzbank, suffered spells of fractiousness with previous ECB president Mario Draghi.
The relationship between Lagarde and Nagel has gained in importance amid general praise, even from some monetary hardliners on the council, for the ECB president’s deft psychological handling of her colleagues compared with the often secretive and acerbic Draghi.
The strength of the Lagarde-Nagel axis was underlined already in July 2022 when the Bundesbank president engineered a 0.5 point rate increase to launch a belated start to the ECB’s tightening cycle. This was part of a bold and somewhat risky compromise with Lagarde and other key council members. To secure bargaining power over winning the sharp interest rate rise, Nagel first agreed to back the ECB’s hotly debated ‘transmission protection instrument’ to safeguard the position of higher-debt euro members.
In other moves to underpin cohesion in the council, Nagel has organised behind-the-scenes diplomatic initiatives with Fabio Panetta and Pablo Hernández de Cos, heads of Banca d’Italia and Banco de España, two central banks whose monetary views in the past have frequently been at odds with the Bundesbank’s.
An intriguing role in delicate ECB council manoeuvrings has been played by Robert Holzmann, president of Oesterreichische Nationalbank. He has frequently taken up provocative minority positions on interest rates as well as other issues such as optimal levels of minimum reserves. Part of Holzmann’s reasoning is that, by adopting extreme positions, he allows leeway for other traditionally hawkish council members such as Nagel and Klaas Knot, president of De Nederlandsche Bank, to present their views as relatively centrist. In line with this strategy, Holzmann was the only member of the council on 6 June to argue against the interest rate reduction, claiming it was premature.
David Marsh is Chairman of OMFIF.
Image source: ECB