European Central Bank holds rates, says domestic price pressures high

The European Central Bank left interest rates unchanged on Thursday, after implementing a cut in June.

“Monetary policy is keeping financing conditions restrictive. At the same time, domestic price pressures are still high, services inflation is elevated and headline inflation is likely to remain above the target well into next year,” the ECB’s Governing Council said in a statement.

The decision — which keeps the key interest rate at 3.75% — was widely expected amid ongoing concern over inflationary pressures, particularly from the labor market.

Euro zone headline inflation dipped to 2.5% in June from 2.6% previously, but the core print — excluding the volatile components of energy and food — came in above a consensus forecast, holding steady at 2.9%.

Analysts expected the central bank to wait for more data across payrolls, economic growth and productivity before easing monetary policy further.

“Wages are still rising at an elevated rate, making up for the past period of high inflation. Higher nominal wages alongside weak productivity have added to unique labor cost growth, although it decelerated somewhat in the first quarter of this year,” ECB President Christine Lagarde said during a press conference.

Lagarde added that the central bank expects inflation levels to fluctuate for the rest of the year but overall decline in the second half due to weaker labor costs, the impact of monetary policy and the fading impact of price shocks.

The ECB cited the inflation outlook, the dynamics of underlying inflation and the strength of monetary policy transmission as the reasons behind trimming rates in June — in the bank’s first such cut since 2019.

In the July meeting statement released Thursday, the Governing Council said it would continue to monitor those areas, and that it was “not pre-committing to a particular rate path.”

However, market pricing suggests firm expectations for two more 25 basis point cuts this year, in September and December, with a pause during the central bank’s October meeting.

Expectations for a rate hold in July meant European markets were little changed following the decision, with the euro continuing to trade slightly lower against the U.S. dollar and higher against the British pound. Stocks were broadly higher across the region.

Switzerland, Sweden and Canada have all cut rates already this year, but sticky U.K. inflation data this week reduced market bets on an August rate cut from the Bank of England, boosting the British pound on Wednesday.

The Thursday statement shows that the ECB remains on course for a September rate cut, Mark Wall, chief European economist at Deutsche Bank Research, said in a note.

“Despite some recent inflation data being less friendly, the ECB has excused some as one-offs and others as absorbed in profit margins. The ECB is taking comfort from the trends and looking through the noise, consistent with being ‘data dependent, not data point dependent’,” Wall said.