The European Central Bank (ECB) is approaching its upcoming September meeting with caution, opting not to commit to an anticipated interest rate cut. This careful approach stands in contrast to market expectations, which largely foresee a rate reduction during the 12 September monetary policy meeting in Frankfurt.

According to the recently published minutes from the ECB’s 17-18 July 2024 meeting, members of the Governing Council expressed a desire to remain flexible and data-driven, avoiding any premature decisions on the future trajectory of interest rates.

The account highlighted the council’s consensus that “there should be no pre-commitment to a particular rate path, given the uncertainty surrounding the pace at which inflation will return to target.” This reflects the ECB’s preference for a gradual policy adjustment, ensuring that any moves align with evolving economic conditions.

Inflation Concerns Persist Despite Restrictive Policies
The ECB’s cautious approach is rooted in the continued resilience of inflation, which has remained stubbornly high despite the central bank’s restrictive interest rate policies. Recent data revealed that inflationary pressures, particularly within the services sector, have been more persistent than expected, even as broader economic indicators have weakened.

Members of the Governing Council noted that the short-term economic outlook had taken on a more “stagflationary” character, with growth risks skewed to the downside. Indicators such as weak manufacturing Purchasing Managers’ Index (PMI) readings have underscored the challenges facing the eurozone economy, which remains unbalanced and heavily reliant on the services sector for recovery.

Labour Market Resilience and Fiscal Policy Concerns
Despite the challenges, the eurozone labour market has shown resilience, with the unemployment rate holding steady at 6.4% in May—the lowest level since the euro’s inception. This strength in the labour market has bolstered hopes for a potential soft landing for the economy.

However, fiscal policy remains a point of concern for ECB policymakers. The minutes noted that political uncertainty and shifts in government across the eurozone could lead to less fiscal consolidation than previously anticipated, further complicating the ECB’s efforts to rein in inflation.

Inflation is expected to hover around current levels for the remainder of the year, influenced by base effects related to energy prices, before gradually declining towards the ECB’s 2% target by 2026. The persistence of services inflation, hovering around 4% since late 2023, continues to shape the overall inflation outlook, with upside risks remaining, particularly from potential wage or profit increases and geopolitical tensions affecting energy prices.

Market Reactions
Following the release of the ECB’s account, the euro remained steady against the dollar, trading at 1.1130 against the greenback at 14:00 CET, near the 13-month high reached earlier in the week. Eurozone equities experienced a relatively quiet session, with the broader Euro Stoxx 50 index edging up by 0.2%. Top gainers included Deutsche Bank, up 3.1%, and Inditex, up 1.8%. Meanwhile, the Spanish IBEX 35 Index outperformed, rising 0.8%, while both the DAX and the CAC 40 gained 0.2%.

As the ECB heads into its September meeting, all eyes will be on how the central bank balances the need for flexibility with the market’s expectations for a potential rate cut.