Euro Zone Economy Faces Risks Without Interest Rate Cuts: ECB Member Warns

A potential dual impact on the euro zone's struggling economy is foreseen if interest rates are not reduced both domestically and in the US, as articulated by European Central Bank Governing Council member Edward Scicluna.

During an interview on Thursday, the dovish Maltese central-bank chief highlighted that the assumption of an economic turnaround and recovery in the latter half of the year is contingent upon the expectation of a less restrictive monetary policy. "It is based on the expectation that our monetary policy becomes less restrictive," he stated, reported Hindustan Times citing Bloomberg.

Euro Zone Economy Faces Risks, Warns Edward Scicluna

In Washington, he expressed concern that failure to lower rates, coupled with a potentially more restrictive monetary policy stance in the US affecting global financing conditions, would represent a significant blow to the euro area economy. He noted that the euro zone's monetary policy is currently quite restrictive and is becoming even more so in real terms as inflation continues to decrease.

Despite President Christine Lagarde's remarks indicating signs of recovery in Europe after more than a year of near stagnation, output across the 20-nation bloc remains fragile. While the prospect of lower borrowing costs offers hope, policymakers are on alert due to concerns about delayed action by the Federal Reserve, compounded by tensions in the Middle East, as reported by Bloomberg.

For the ECB, consumer-price gains have been moderating and are now approaching the 2% target, which could pave the way for a reduction in the deposit rate from its current record high of 4% in June.

"We shouldn't prematurely declare victory over inflation," Scicluna cautioned. "But we also shouldn't overdo it and find ourselves in a situation where inflation is too low and we struggle to bring it back to 2%."

Such a scenario would echo the years following Europe's debt crisis, during which the ECB slashed rates to below zero and conducted large-scale securities purchases through quantitative easing to counter the threat of deflation. Scicluna stressed that if projections indicate a likelihood of falling short of the inflation target, officials should not hesitate to take more assertive measures, as per Bloomberg report.

"If our baseline scenario materializes and inflation continues to trend downwards, a 25 basis point rate cut in June might be appropriate," he explained. "However, if inflation surprises us further on the downside and our projections suggest only 1.7% or 1.8% inflation by 2025, this could necessitate a 50 basis point cut. In such a case, we should not delay and should opt for the 50 basis point reduction."