High services inflation means 'gradual' rate cuts still needed, says Gabriel Makhlouf

The prospect of a 0.5% rate reduction was discussed by the European Central Bank on Thursday but was ultimately decided against

Governor of the Central Bank of Ireland, Gabriel Makhlouf, said some components of inflation are “still too high for comfort” notably services inflation. File photo

Governor of the Central Bank of Ireland, Gabriel Makhlouf, has said he remains in favour of a more gradual reduction in interest rates, rather than larger moves, as inflation in areas such as services and food continues to remain high.

On Thursday, the European Central Bank (ECB) announced a further cut to interest rates of 0.25% amid growing concerns that the economic recovery across the eurozone is losing momentum. ECB president Christine Lagarde said that a 0.5% rate cut was considered but they ultimately decided against it.

This comes following concerns that the ECB hasn’t eased its monetary policy fast enough to support the European economy.

The ECB noted a slower economic recovery than was seen in the September projections with the eurozone economy expected to grow by just 0.7% this year and 1.1% next year. Headline inflation is expected to average out at 2.4% this year and 2.1% next year. The ECB’s goal is to get inflation to 2% over the medium term.

Mr Mahklouf said the disinflation process remains on track which allowed the rate reduction to go ahead, however, some components of inflation are “still too high for comfort” notably services inflation.

“While food inflation is somewhat higher than expected, the latest data show that all other components are below our projections from September," Mr Makhlouf said, adding that they expect food price inflation to peak around 3.2% in the middle of next year before reducing down to 2%.

On services inflation, Mr Makhlouf said it makes up two-thirds of core inflation. Core inflation doesn’t include food or energy prices which can be volatile.

“Services inflation is taking longer to fall back to pre-pandemic norms, hovering around 4% in the eurozone for all of 2024. I want to see services inflation closer to 3% in order to be more in-line with our target,” he said. “The ongoing easing of wage pressures in the euro area should help with this.” 

Mr Makhlouf said he continues to favour a “gradual reduction” in rates rather than larger moves considering inflation in areas such as services remains higher than they would like.

Economy

On the economy, Mr Makhlouf said the picture for the eurozone is “more mixed” with better-than-expected data during the third quarter offset by some underlying weaknesses.

“There are also significant cross-country differences, with countries that are more reliant on manufacturing facing weaker growth prospects,” he said.

The ECB is expecting consumer spending to be the main driver of growth in the near-term supported by wage growth and falling inflation.

On the Irish economy in particular, he said “underlying conditions are quite different” with steady growth expected this year “giving rise to concerns over potential infrastructure bottlenecks that constrain sustainable growth”.

Mr Makhlouf said that as inflation becomes more stable, the attention of monetary policy makers will return to “medium-term considerations” such as the effect on economic growth.

Although interest rates are expected to continue to decrease next year, the ECB did not commit to a particular rate path.