Portuguese bank chief: ECB may need to accelerate interest rate cuts

LISBON – The European Central Bank may have to up the pace of interest rate cuts as data published since last week’s cut suggest growth and inflation could fall short of the Bank’s new projections, said rate-setter Mário Centeno.

 “Given the position in which we are today, in the monetary policy cycle, we have really to minimize the risk of undershooting, because that’s the main risk,” Centeno, Bank of Portugal Governor and a member of the ECB’s Governing Council, told POLITICO in an interview.

Centeno’s remarks are the clearest sign yet that an interest rate cut on October remains a real possibility, as the ECB wrestles with the problem of how fast to ease policy in an economy struggling to build any momentum, but also struggling to conclusively defeat inflation.

 ECB President Christine Lagarde hinted last week, as the Bank cut its key rate for a second time this year, that there would be no further action until December. While ECB chief economist Philip Lane on Monday affirmed that policymakers “should retain optionality” about a cut in October, hawks on the Governing Council have stressed it “would require a significant shift” to consider what would be back-to-back cuts.

No big shock needed to accelerate easing

Centeno readily challenged that idea, arguing that, in the end, the U.S. Federal Reserve — which cut its key interest rate for the first time in four years on Wednesday — hadn’t needed a big change in the economic data to change its tone, ultimately opting for a hefty 50 basis point cut.

While the pace of job creation has slowed in the U.S. and certain sectors of the economy have weakened, gross domestic product was still growing at a healthy rate at the start of the third quarter.

“The most recent data for the U.S. was worse than expected numbers for the labor market, but it was not a big shock,” Centeno said.

Wage growth slowing, ZEW gloomy

Centeno, a former Eurogroup chief and one of the Governing Council’s more “dovish” members, said data released in Europe since last week’s rate decision cast doubt on the ECB’s baseline assumptions, possibly pointing to an earlier cut.

“We already have new information,” he said, pointing to data released on Monday that showed slower wage growth in the first half of the year. “This deceleration of wage growth is good news for inflation.”

In addition, data on investors’ morale in Europe and especially in Germany, showed “a sharp decrease, well below expectations,” he said.

The German ZEW sentiment index on Tuesday painted a dire picture, with the assessment of the current situation now almost as bad as it was at the beginning of the Covid pandemic in spring 2020. ZEW head Achim Wambach said “the hope for a swift improvement in the economic situation is visibly fading.”

For Centeno, such data points are part of a pattern showing broad disinflation.

“We do see less inflationary pressure from trade, and, domestically, from the consumption-versus-saving decisions,” he said.

The one exception, he added, is services inflation, which continues to run at above 4 percent, but which isn’t directly targeted by the ECB. Overall, the latest ECB inflation forecasts show inflation show inflation easing from 2.5 percent this year to 1.9 and thus a notch below target in 2026.

Labor market risks

Centeno pointed out that, while inflation has panned out pretty much as expected since early 2023, investment has fallen well short of what the ECB expected, sapping the growth dynamic.

“If we compare the current forecast with what was our forecast at the beginning of the summer 2023, we cut the expectations of investment growth by 80 percent,” he said. “That’s where I am most worried for Europe right now. Investment is not increasing — despite the Next Generation EU push, public investment is booming in most of our countries, but private investment is not following suit.”

A second area of concern is the labor market, which Centeno fears is not as strong as a near record-low jobless rate of 6.4 percent in July suggests. A labor economics specialist, Centeno pointed out that since the ECB started hiking interest rates in the summer of 2022, new vacancies posted have fallen by 20 percent. Employment growth, meanwhile, has slowed markedly.

At the same time, the number of people who have lost their job over the last three months has risen by 8 percent.

“Something that we know from labor economics is that firms synchronize directions more in downturns than in upswings,” Centeno said, warning that this means jobless numbers could rise quickly. In Germany, the eurozone’s current problem child, the jobless rate has already risen from a low of 5 percent in 2022 to 6 percent today.

This points to risks of weak demand and, by extension, less need to curb it with high interest rates. And Centeno says the key rate is still clearly in restrictive territory:  he estimates that the natural rate of interest, at which monetary policy neither constrains nor boosts growth, is no higher than 2.5 percent, and may be a full percentage point lower.

Centeno also dismissed suggestions that the short time between the September and October Council meetings would by itself preclude another cut next month.

“I don’t think five weeks is a short period of time,” he said. “I was Finance Minister, I had to take decisions at 7:30 in the morning, 7:45, 8:15. Five weeks is plenty of time for us to go back to the data, to look at it again, to value what each piece of data is telling us.”

(This article has been updated to reflect the Fed’s rate cut on Wednesday.)