Explainer: Why ECB’s rate cut could be risky

The European Central Bank is poised to make another interest rate cut this Thursday, just a few weeks after the last one. However, there are some compelling reasons why this move might be too risky.

First, core inflation has been declining in part due to indirect effects of falling energy prices. This situation mirrors what happened last autumn. Second, wage growth in the eurozone has been accelerating, reaching a high of 4.5%, which is incompatible with the ECB’s inflation target. This contradicts the central bank’s assertion that wage growth has slowed.

Third, Labour shortages persist in many eurozone countries. This is hindering business operations for a significant number of companies. Lower interest rates could exacerbate these shortages by increasing corporate investment demand. This, in turn, could lead to higher wage settlements and inflation.

Finally, caution is warranted after a period of high inflation. Memories of the inflation shock are likely to linger, and long-term inflation expectations may not be as firmly anchored at 2%. The ECB should maintain a restrictive monetary policy for a longer period to avoid a repeat of the mistakes made after the oil price shocks of the 1970s. Premature easing could lead to a resurgence of inflation.


Economists consider the ECB’s rate cut a risky decision for several reasons:

Inflationary Pressures: Despite recent declines in headline inflation, core inflation remains elevated. A rate cut could stimulate economic activity, potentially leading to increased demand and higher prices.
Wage Growth: Rising wages are a key driver of inflation. A rate cut could further fuel wage growth, especially in a tight labor market.

Labour Shortages: Many eurozone countries are grappling with labor shortages. Lower interest rates might exacerbate these shortages by encouraging businesses to invest and expand their operations.

Anchoring Inflation Expectations: The ECB has been working to anchor inflation expectations at 2%. A premature easing of monetary policy could undermine these efforts and lead to a resurgence of inflation.

Global Economic Uncertainty: The global economic outlook remains uncertain, with risks such as geopolitical tensions and supply chain disruptions. A rate cut might make the eurozone economy more vulnerable to these shocks.

In essence, there is a concern that a rate cut could reignite inflationary pressures, exacerbate existing economic imbalances, and make it more difficult for the ECB to achieve its inflation target.

The decision of the ECB to cut interest rates in October 2024 was widely anticipated by economists and financial market participants. ECB officials had been signaling their intention to ease monetary policy in response to slowing economic growth and declining inflation.  

However, there were also concerns that the ECB might be moving too quickly to cut rates, especially given the ongoing inflationary pressures in the eurozone. Some economists argued that core inflation was still too high, and that the ECB should wait for more concrete evidence of a slowdown in price growth before easing monetary policy.

Ultimately, the ECB decided to proceed with the rate cut, citing the need to support economic activity and prevent a potential recession. However, the central bank also emphasized that it would remain vigilant about inflation risks, and that it would be prepared to adjust its policy stance if necessary.  

In the light of the latest comments and statements by ECB officials, it is obvious that the central bank is balancing the need to support economic growth with the need to contain inflation. While the rate cut is a significant step in the direction of easier monetary policy, the ECB is also signaling that it is prepared to be flexible and responsive to changing economic conditions.