ECB Hawkish Member: Service Inflation Worry Trumps Economic Slowdown

The hawkish member of the European Central Bank's Governing Council, Martins Kazaks, stated on Monday that the current persistent inflation trend in the service sector poses a greater risk than his concerns about the slowdown in the economic growth of the Eurozone. Kazaks' latest views are largely in line with those of ECB President Christine Lagarde and others, suggesting that although the ECB has already cut interest rates twice, future policy directions will depend on data such as inflation, rather than following the aggressive rate-cutting path priced in by the market.

"In my view, the risk of service price inflation remains greater, but as we move forward step by step, we will have a clearer picture of how the inflation situation develops," the ECB Governing Council member and Governor of the Bank of Latvia said in an interview on Monday. "There is no doubt that the direction of interest rates is downward. However, the speed of rate cuts will depend on the pace of further economic development."

Last month, the growth rate of consumer prices in the Eurozone (i.e., CPI increase) slowed to 2.2%, and it is expected to continue to decelerate in September, even though the Eurozone's service sector inflation rate hovers around a relatively high level of 4%. Meanwhile, the Eurozone's economic output failed to rebound as expected, and the ECB lowered its economic growth forecasts for 2024-2026 when it announced a rate cut earlier this month.

The ECB lowered its economic growth forecasts up to 2026, while inflation expectations are largely in line with previous forecasts.

Kazaks, who has always leaned towards a hawkish stance among the ECB Governing Council members, said in the interview that the ECB must be "very careful and not be surprised by the price pressures in the service sector," but added that "another factor works in the opposite direction, which is the weak trend in the economy," but its risk level is not as high as the stubborn service sector inflation.

"Economic growth is weak, so if interest rates remain high for too long, it could lead to an unnecessary slowdown in the economy and an increase in unemployment," Kazaks said.

When the ECB announced a rate cut in September, it did not provide clues about when the next rate cut would occur and the potential magnitude of the cut. Lagarde and other ECB Governing Council members are waiting for data on the extent of the Eurozone's economic deterioration and how this will change the inflation trend.

Earlier in September, the ECB cut interest rates for the second time this year. The ECB lowered the deposit facility rate by 25 basis points to 3.5%, the main refinancing rate by 60 basis points to 3.65%, and the marginal lending rate by 60 basis points to 3.9%. At the same time, the ECB reiterated that it would not make specific commitments on interest rates. Lagarde simply stated that the downward trajectory of interest rates is "quite clear."

Joachim Nagel, a member of the ECB's Governing Council and also leaning towards a hawkish stance as the head of the German Bundesbank, recently said that the ECB has made good progress in reducing inflation, but it will take patience to fully achieve the 2% target. Nagel said in a recent interview: "We must now show policy endurance. If we can do this, then we will soon reach the finish line." Nagel also said that the future path of interest rates is open, but borrowing costs "certainly will not rise as quickly and sharply as they did."

David Powell, a senior economist in the Eurozone, said: "The ECB's Governing Council may resist the pressure to cut interest rates again in October and wait until December when there is more data on price pressures before cutting rates."