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The situation related to the "radicals" of the European Central Bank
In the decision-making system of the European Central Bank, there are factions with different positions, among which the "radicals" have a more distinct attitude towards interest rate policy and other aspects.
1、 The Composition and Characteristics of the Radical Faction
Members: For example, officials such as Austrian Central Bank Governor Robert Holzmann can be considered more radical members. These members often hold strong views in interest rate decision-making discussions, and in previous interest rate hike cycles, they actively promoted the interest rate hike process. In 2023, despite facing the global market panic caused by the collapse of Silicon Valley banks and the Credit Suisse crisis, the European Central Bank still chose to raise interest rates, and officials like Robert Holzmann supported larger rate hikes. This radical attitude reflects their determination to control inflation and other goals.
Decision tendency characteristics: When making monetary policy decisions, they rely more on core economic data indicators, such as inflation data, economic growth data, etc. They often have a lower tolerance for inflation issues. When the inflation rate is much higher than the target (such as the Eurozone's inflation target of 2%) and shows a stubborn trend, there will be a strong demand for measures such as interest rate hikes to curb inflation. In the current expectation of interest rate cuts, they also made bolder decisions and predictions based on data. For example, seeing that inflation in the eurozone is experiencing a cooling trend (with September's inflation rate falling to 1.7% beyond expectations), they have begun to consider the possibility and magnitude of interest rate cuts. Although they are still concerned that inflation may be stronger than expected, if inflation data supports it, they hope to see interest rates lower to neutral levels faster, which reflects their aggressiveness in policy adjustments. Once they believe that the economic situation and data support it, they cannot rule out a significant adjustment of interest rate policies.
2、 The influence of radicals in the decision-making of the European Central Bank
Internal decision-making drive: When discussing interest rate policies at internal meetings of the European Central Bank, the views of "radicals" often attract widespread attention and discussion. Despite internal differences of opinion, known as the 'Eagle Dove War', the voices of the 'radicals' played an important role in driving decision-making towards a more radical direction. During the interest rate hike cycle, their proposals prompted the European Central Bank to raise interest rates multiple times in response to inflationary pressures. For example, during the period of 2023-2024, the inflation situation in the eurozone is complex, with stubborn core inflation. The push of "radicals" has led the European Central Bank to maintain a pace of interest rate hikes for a period of time, attempting to bring the inflation rate back to the target level.
The impact on market expectations: Their statements and attitudes can also have a significant impact on market expectations. Market participants will closely monitor the statements of "radical" officials, as they may indicate the future policy direction of the European Central Bank. When radical officials mention the possibility of a 50 basis point interest rate cut in December, the market will adjust its investment strategy, exchange rate expectations, etc. based on these signals. For example, traders will increase their bets on the European Central Bank's interest rate cut based on this information. Currently, the market is betting on a 20% chance of the ECB cutting interest rates by 50 basis points in December, reflecting the direct impact of "radical" rhetoric on market expectations.
The impact of the European Central Bank's interest rate cuts
1、 Impact on the Eurozone
(1) In terms of economic growth
Stimulating corporate investment and consumption: interest rate cuts mean lower borrowing costs for both businesses and individuals. With the continuous increase in wage levels and the suppression of inflation, enterprises have more funds to invest in expanding production, such as updating equipment and launching new projects. For individuals, it may stimulate consumption, such as increasing loan consumption, buying a house, and other behaviors. From a data perspective, in the first quarter of 2024, the Eurozone created approximately 500000 new jobs and increased employment by 0.3%. The unemployment rate dropped to 6.4% in April 2024, reaching its lowest level since the establishment of the Eurozone. This is partly due to interest rate cuts stimulating economic growth and driving employment growth.
Stable manufacturing industry: The manufacturing industry in the eurozone has been affected by factors such as high interest rates, resulting in problems such as reduced corporate investment and production outflows. After the interest rate cut, the operating costs of enterprises have decreased, which helps alleviate the problem of manufacturing outflow and stabilizes the manufacturing industry at a low level. For example, some manufacturing enterprises that rely on borrowing for production and operation have reduced their financial pressure after interest rate cuts, and are more capable of maintaining production scale or even expanding production.
Export under the influence of exchange rate: Before the Federal Reserve cuts interest rates, the euro against the US dollar may have a relatively weak trend after the European Central Bank cuts interest rates. For example, from June 6, 2024 to June 19, 2024, the euro fell by 1.06% against the US dollar. The relative weakness of the euro may benefit exporters in the eurozone, as their goods are priced more competitively in the international market, which is beneficial for the eurozone's export trade and drives economic growth.
(2) In terms of price level
Limited inflationary pressure: Generally speaking, interest rate cuts may theoretically lead to price increases. But currently, the inflation rate in the eurozone has gradually fallen back to near the 2% inflation target level anchored by the European Central Bank, and the market has sufficient and stable expectations for sustained improvement in price levels beforehand. Therefore, in the current economic and financial environment, a single interest rate cut has a limited impact on future inflation in the eurozone and will not lead to an uncontrolled inflation level in the eurozone.
2、 External impact on the Eurozone
(1) In terms of global financial markets
Capital flow: As one of the major economies in the global open economy, after the Eurozone cuts interest rates, some European capital may flow to emerging market countries, including China. This is because emerging market countries may have higher investment returns at this time, and capital tends to flow towards regions with higher returns.
Bond market: Since March 2022, the interest rates of sovereign bonds in the Eurozone have shown a continuous upward trend, and there is room for international capital to increase investment in European bonds after interest rate cuts. For example, from June 6, 2024 to June 14, 2024, the price of 10-year Eurozone government bonds increased while the yield decreased from 2.69% to 2.41%, indicating that the interest rate cut had a positive impact on the Eurozone sovereign bond market and attracted more capital inflows into the bond market.
(2) In terms of global central bank monetary policy
Demonstration effect: The Federal Reserve has not yet cut interest rates, and since the outbreak of the European debt crisis, especially since the European Central Bank adopted a negative interest rate policy in 2014, the divergence between the monetary policies of the European Central Bank and the Federal Reserve is not uncommon. In addition, considering the relatively strong economic resilience of the United States in the G7 group, the European Central Bank's interest rate cuts may have a demonstration effect on central banks of developed economies outside the United States. In the future, when formulating policies related to interest rate cuts, central banks of other economies may refer to the considerations of the European Central Bank on the factors of interest rate cuts and the selection of the magnitude of interest rate cuts.
(3) In terms of international trade
The impact on the export stability of emerging market countries: After the European Central Bank cuts interest rates, in addition to the potential benefits for exporters in the eurozone due to the relative depreciation of the euro and more competitive commodity exports, the enhanced economic resilience of the eurozone in the future will be beneficial for improving the stability of emerging market countries' exports to the eurozone. The stable development of the Eurozone economy means that its import demand will also be relatively stable, which is a positive factor for the export trade of emerging market countries.
Analysis of the possibility of the European Central Bank cutting interest rates in December
1、 Factors supporting the December interest rate cut
(1) Economic growth data
The economic performance of the Eurozone has been lower than expected, with new data indicating a further slowdown in economic growth. If the year-on-year GDP growth rate of the Eurozone in the first quarter of 2024 is only 0.1%, this data reflects the weak economic growth in the Eurozone. Although the GDP growth rate of the Eurozone in the first quarter of 2024 was 0.3% based on month on month data, the overall economic growth momentum is still insufficient. In this situation, interest rate cuts are a feasible monetary policy measure to stimulate economic growth, so there is a high possibility of a rate cut in December.
(2) Inflation data
The downward trend of inflation in the Eurozone has been smooth, with the inflation rate in September exceeding expectations and falling to 1.7%, which is close to the 2% target set by the European Central Bank. This gives the European Central Bank more operational space in terms of inflation, and interest rate cuts will not bring significant risks of inflation spiraling out of control. Moreover, from the perspective of market expectations, there is currently less concern about uncontrolled inflation and more focus on economic growth issues, which also provides favorable conditions for the December interest rate cut.
(3) Policy inertia and market expectations
The European Central Bank has already carried out three interest rate cuts in 2024 (in June, September, and October), and the inertia of this policy may continue until December. The market has formed certain expectations for the European Central Bank's interest rate cut, and traders have increased their bets on the ECB's interest rate cut in December. They expect a 20% chance of a 50 basis point cut, and the market has almost fully priced in the possibility of the bank cutting interest rates at every meeting before April next year. If the European Central Bank does not cut interest rates, it may have a certain impact on market confidence. In order to maintain policy coherence and stabilize market expectations, a December interest rate cut is a more likely choice.
2、 Factors hindering the December interest rate cut
(1) Internal differences of opinion
Although some officials, such as "radicals," believe that a rate cut is necessary or even consider a significant 50 basis point cut, there is no consensus within the European Central Bank. Some officials may have different interpretations of economic data or different concerns about the speed and magnitude of interest rate cuts. For example, some officials may be concerned that excessive interest rate cuts could trigger other risks, such as instability in financial markets and squeezing future monetary policy space. The lack of internal consensus may hinder the smooth decision to cut interest rates in December.
(2) Inflation uncertainty
Although the inflation rate is currently on a downward trend and approaching the target level, there is still an upward risk. Austrian central bank governor Robert Holzmann is concerned that inflation may be stronger than expected, although he does not rule out the possibility of a 50 basis point interest rate cut in December, the uncertainty of this inflation is still a factor to consider. If there is an unexpected rebound in inflation data before December, it may prompt the European Central Bank to reconsider its decision to cut interest rates.
Case of the European Central Bank cutting interest rates by 50 basis points (hypothetical analysis, no actual cases have occurred)
1、 Strong stimulating effect on the economy
(1) At the enterprise level
If the European Central Bank cuts interest rates by 50 basis points, the borrowing costs of enterprises will be significantly reduced. For large enterprises, this means that the cost of capital will be significantly reduced when undertaking large-scale investment projects, such as building new factories, researching and developing new technologies, etc. Taking a company planning to invest 100 million euros in building a new factory as an example, with a 50 basis point interest rate cut, its loan interest expenses will be greatly reduced, which may prompt the company to start the project ahead of schedule or expand the project scale. For small and medium-sized enterprises, they often face higher costs and difficulties in obtaining funds. A 50 basis point interest rate cut may restart some projects that were originally put on hold due to high funding costs, which will help the development of small and medium-sized enterprises and drive employment and overall economic activity.
(2) At the consumer level
On the consumer side, a 50 basis point interest rate cut may further stimulate consumption. For example, for housing loans, consumers' repayment pressure will be significantly reduced, which may encourage some consumers who have the intention to buy a house but are limited by high interest rates to enter the market. The same applies to large consumer loans such as cars, as consumers may be more willing to take out loans for consumption, thereby driving the prosperity of the consumer market. This will further stimulate domestic demand and have a positive impact on economic growth.
2、 Significant impact on the financial market
(1) Bond market
In the bond market, a 50 basis point interest rate cut by the European Central Bank will lead to a significant increase in bond prices. Due to the inverse relationship between bond prices and interest rates, a significant interest rate cut will cause a relative decrease in the yield of issued bonds, thereby attracting more investors to purchase bonds and driving up bond prices. This may lead to increased volatility in the bond market, and for some financial institutions that hold a large amount of bond assets, their asset value will significantly increase, but they also face the risk of interest rate fluctuations. For example, some pension funds and insurance companies hold large amounts of bond assets, and significant fluctuations in bond prices may affect their balance sheet structure and the stability of long-term returns.
(2) Exchange rate market
In the exchange rate market, a 50 basis point interest rate cut may cause a significant depreciation of the euro exchange rate. This will have a stronger impact on the import and export trade of the eurozone. On the one hand, the depreciation of the euro will make exports in the eurozone more competitive, and the profits of export enterprises may increase significantly, further stimulating the development of the export industry; On the other hand, for importing enterprises, the cost of imports will increase, which may lead to increased pressure on domestic prices, especially for enterprises that rely on imported raw materials. The rise in costs may compress their profit margins.
Interpretation of the European Central Bank's interest rate policy
1、 The objective of the European Central Bank's interest rate policy
(1) Stable prices
The primary goal of the European Central Bank is to maintain price stability and keep inflation rates close to but not exceeding 2%. This goal is based on the consideration of the overall stable development of the eurozone economy. When the inflation rate is too high, such as during the period of 2022-2023, the eurozone faces high inflation pressure, and the European Central Bank uses measures such as interest rate hikes to curb inflation. When the inflation rate gradually falls back and approaches the target level, such as in 2024, interest rate cuts are being considered to maintain price stability while promoting economic growth. For example, in 2024, as the inflation rate dropped to nearly 2%, the European Central Bank made multiple interest rate cuts to prevent deflation risks caused by low inflation rates, while also stimulating economic development on the basis of price stability.
(2) Promote economic growth
In addition to stabilizing prices, promoting economic growth in the eurozone is also an important goal. When economic growth is sluggish, the European Central Bank will stimulate the economy by adjusting its interest rate policy. For example, when seeing slow GDP growth, reduced corporate investment, and poor employment conditions in the eurozone, such as a year-on-year GDP growth rate of only 0.1% in the first quarter of 2024, the European Central Bank reduces borrowing costs for businesses and individuals through interest rate cuts, thereby stimulating corporate investment and personal consumption to drive economic growth. In this process, interest rate policy has become an important tool for regulating the economic cycle.
2、 The decision-making mechanism of the European Central Bank's interest rate policy
(1) Data dependency
The interest rate policy decisions of the European Central Bank are highly dependent on economic data. Including inflation data (such as monthly year-on-year growth rate of CPI), economic growth data (such as GDP growth rate), employment data (such as unemployment rate), etc. For example, when deciding whether to raise or lower interest rates, close attention will be paid to whether inflation data deviates from the target value and whether economic growth meets expectations. In 2024, after seeing data indicating a decrease in inflation rates and a slowdown in economic growth, the European Central Bank made the decision to cut interest rates. This data-driven decision-making mechanism helps ensure the scientific and rational nature of interest rate policies, and can make timely adjustments based on changes in the economic situation.
(2) Internal discussion and consensus
Within the European Central Bank, interest rate policy is determined through discussions and consensus among members of the board of directors. The members of the council include central bank governors and other officials from various countries in the eurozone, who have different economic backgrounds and perspectives, and will engage in thorough discussions when making interest rate policy decisions. When discussing whether to cut interest rates in December and the magnitude of the rate cut, different officials will put forward different opinions based on their own analysis and considerations of the domestic economy. For example, "radicals" may advocate for a larger rate cut, while other officials may be more cautious and ultimately need to reach a certain consensus internally to determine the interest rate policy. This mechanism of internal discussion and consensus helps balance the interests of different countries and regions, while also being able to make more comprehensive decisions by integrating various perspectives.
3、 The Relationship between the European Central Bank's Interest Rate Policy and the Global Economy
(1) The impact of the global economic environment
The global economic environment has a significant impact on the interest rate policy of the European Central Bank. Against the backdrop of slowing global economic growth, such as the IMF's projected global economic growth rate of 3.2% in 2024, far below the historical average of 3.8% before the pandemic (2000-2019), the eurozone is facing pressures such as reduced external demand and changes in trade terms. This external environment has prompted the European Central Bank to adjust its interest rate policy in response to challenges. For example, factors such as the rise of global trade protectionism and the continued escalation of geopolitical conflicts have impacted the relatively high foreign trade dependence of the eurozone economy. The European Central Bank has increased the economic competitiveness of the eurozone by cutting interest rates, reducing interest rate differentials with other major economies, and thus maintaining a relative advantage in the global economic landscape.
(2) Demonstration effect on global monetary policy
As one of the central banks of major economies worldwide, the European Central Bank's interest rate policy has a demonstrative effect on other central banks. When the European Central Bank cuts interest rates, other developed economy central banks may refer to the decision-making factors and magnitude choices of the European Central Bank. For example, in 2024, the European Central Bank's interest rate cuts may have an impact on the central banks of developed economies outside the United States when formulating policies related to interest rate cuts. Other central banks may adjust their monetary policies based on the European Central Bank's judgment of the economic situation, handling of the relationship between inflation and economic growth, and other experiences. This also reflects the importance of the European Central Bank's interest rate policy in the global monetary policy system.