Interest rates are close to 'cruising altitude', says ECB President

The European Central Bank (ECB) will continue its rate hikes, but the "cruising altitude" is approaching, as inflation recedes, its president Christine Lagarde said Thursday at a banking congress. "We will continue to move forward - with determination and without discouragement - until we see inflation return to our medium-term target of 2% in due time", declared Christine Lagarde in Hanover, before the congress of Caisses German savings.

Over the past nine months, the monetary institution has decided on seven rate hikes in a row, ie a cumulative 3.75 percentage points, with a step of 0.25 point in May, which was the lowest of the cycle. “At the start, the plane should climb steeply and accelerate quickly. But as it approaches its target altitude, it can reduce the acceleration and maintain its current speed,” explained the French central banker in a metaphorical tone. “Now we are approaching our cruising altitude,” she added.

The effects of these accumulated rate hikes are visible - ebb in credit, slump in demand and therefore in activity - but the ECB is still far from having won the battle against high inflation, even if the aggregate is clearly on the back. Since its peak at 10.6% year-on-year last October, inflation in the euro zone fell to 6.1% in May, according to Eurostat on Thursday. This is still three times above the target set by the ECB.

“We therefore expect the ECB to raise interest rates twice by more than 25 basis points in June and July before leaving them unchanged”, which would take the deposit rate to 3.75%, according to Salomon Fiedler, an analyst at Berenberg. While headline inflation is falling, due to a drop in energy prices, outside of this component, so-called “core” inflation remains high, fueled by wage increases. The latter “become a more important engine of inflation”, according to Christine Lagarde.

The unemployment rate in the euro zone is at its lowest and workers have strong bargaining power to recover past losses in purchasing power, for example in Germany. However, “the longer inflation will remain above our target, the greater the risk that it will infiltrate people's expectations,” warned Christine Lagarde. The ECB sees inflation returning to 2% "before the second half of 2025", which will be four years of exaggerated price increases.