Mar 20, 2024 - Economy

ECB chief Lagarde lays out three-part test for rate cuts

ECB president Christine Lagarde

ECB president Christine Lagarde speaks Wednesday in Frankfurt. Photo: Alex Kraus/Bloomberg via Getty Images

In Europe, as in the U.S., interest rate cuts look to be on the horizon — but there isn't enough evidence to definitively say so just yet.

Why it matters: That's the takeaway from a nuanced speech Wednesday by European Central Bank president Christine Lagarde, who laid out what she needs to see before easing policy in the 20 countries using the euro.

  • It reflects migration away from a period when central bankers on both sides of the Atlantic were more willing to give explicit forward guidance about when to expect a policy move.
  • And while the details of the economic challenges in the U.S. and Europe differ, the test Lagarde laid out for potential rate cuts holds lessons for stateside policy, too.

Driving the news: Lagarde, speaking at the ECB and its Watchers conference in Frankfurt, laid out three tests the central bank will apply in deciding when it's time to cut interest rates. "Put simply, we need to move further along the disinflationary path," Lagarde said.

  • First is wage growth, with the ECB looking for "data to confirm whether wages are indeed growing in a way that is compatible with inflation reaching our target sustainably by mid-2025."
  • Second is whether corporate profit margins compress, allowing inflation to come down without pain in the labor market.
  • Third is productivity growth — which could allow the European economy to grow more rapidly even as inflation dissipates.

Between the lines: Some aspects of this framework align with that in the U.S., whereas others don't. Most Fed officials have not emphasized profit margins as a significant driver of inflation, for example (many left-of-center economic commentators have, by contrast).

  • And wage growth in Europe is more influenced by formal bargaining with massive sectoral labor unions than is the U.S., which the ECB will be watching closely.

Yes, but: What the U.S. and Europe have in common as their central banks weigh when and whether to cut interest rates is a sense that in these stormy seas of the last few years, it would be foolish to be overly confident about what policy will look like three, six or 12 months in the future.

  • Said Lagarde, "our decisions will have to remain data dependent and meeting-by-meeting, responding to new information as it comes in," adding that "even after the first rate cut, we cannot pre-commit to a particular rate path."
  • She then ad-libbed to attendees whose job is to predict her next move, "however tempting that is. However much each of you would like to see it."
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