ECB’s Christine Lagarde says ‘darkest days’ of high inflation are behind Eurozone

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European Central Bank president Christine Lagarde has come closer than ever to claiming victory in the fight against inflation, saying “the darkest days of winter look to be behind us” and that further interest rate cuts were likely.

“The direction of travel is clear and we expect to lower interest rates further,” Lagarde said in Vilnius on Monday.

Lagarde’s remarks are likely to bolster financial markets’ expectations of more ECB cuts. Investors have already been pricing in a series of back-to-back moves in the benchmark deposit rate over the first half of 2025 on signs of weak growth and diminishing price pressures.

The ECB last week lowered borrowing costs for the fourth time this year by a quarter-point to 3 per cent and watered down its hawkish language.

Lagarde on Monday said the long-standing risk that high underlying inflation could derail the return to price stability had “recently” subsided.

The ECB began raising interest rates in 2022 after a spike in prices following a post-pandemic surge in demand, global supply chain bottlenecks and rising energy costs after Russia’s invasion of Ukraine.

Inflation hit a record high of 10.6 per cent in late 2022, more than five times the ECB’s 2 per cent goal.

Annual inflation has fallen rapidly over this year, coming down to 2.3 per cent in November. It is expected to hit 2.1 per cent next year and 1.9 per cent in 2026, according to the ECB’s latest projections, published last week.

“There is now greater alignment between our forecasts and underlying inflation,” Lagarde said on Monday, adding that the ECB was now “close to achieving our [2 per cent] target”.

High wage growth, the ECB’s main remaining concern, would subside from 4.8 per cent this year to 3 per cent in 2025, she said: “The level we generally consider to be consistent with our target.”

Lagarde singled out the Eurozone’s weaker than expected economic recovery as a “downside risk” to inflation, pointing out that “small sequential downward revisions to the growth outlook” since 2023 “amounted to a quite significant downgrade over time”.

While the central bank last summer predicted an annual 1.8 per cent increase in GDP for 2024, it now only forecast growth of 0.7 per cent for this year.

The contraction in Eurozone business activity eased at the end of the year, according to a survey that showed a return to growth in services was offset by a continued reduction in manufacturing output. The flash composite purchasing managers’ index, which is compiled by S&P Global and Hamburg Commercial Bank, rose to 49.5 in December from 48.3 a month earlier.

The figure was above the 48.2 forecast from economists polled by Reuters, but still below the 50-point mark that separates growth from contraction.

“The PMI is still lower than it was in October, and on past form remains consistent with the economy contracting,” said Jack Allen-Reynolds, economist at Capital Economics. “The data will strengthen ECB policymakers’ view that further rate cuts are needed.”

Lagarde said geopolitical uncertainties could alter “the risk appetite of investors, borrowers and financial intermediaries”. The ECB’s main concern is that a dramatic and uncontrolled widening of bond spreads between Eurozone member states could make monetary policy less effective.

“Assessing monetary transmission will continue to be important,” Lagarde said.

“If we face large geopolitical shocks that significantly increase uncertainty about the inflation projections, we will need to draw on other sources of data to make the risk assessment surrounding our baseline outlook more robust.”

Additional reporting by Valentina Romei