ECB Policymakers Divided Over Downturn’s Impact, Sources Report

By Balazs Koranyi

FRANKFURT – European Central Bank (ECB) policymakers are increasingly divided over the future of economic growth, a split that could influence discussions on rate cuts in the coming months. Some members are concerned about the potential for recession, while others remain focused on ongoing inflation challenges, according to sources familiar with the discussions.

Following an interest rate cut in June, the ECB is expected to ease rates again in September in response to a slowdown in price growth. However, future policy decisions may prove more complex as the eurozone economy faces increasing uncertainty, as indicated by conversations with various insiders.

The core of the debate revolves around how economic slowdown and the possibility of a recession might affect inflation—an area of primary concern for the bank as it aims to reduce inflation to 2% by the end of 2025.

While much of the dialogue remains confidential, discussions reveal significant differences in opinion. The ECB has not commented publicly on these matters.

Dovish policymakers, who are currently in the minority, contend that the economy is weaker than previously believed, with rising recession risks. They point out that companies accumulating labor are now beginning to reduce job openings, which softens the labor market.

A decline in employment leads to reduced disposable income, which can quickly diminish consumption and trigger a self-reinforcing economic downturn. One insider noted, “This would weaken price pressures more rapidly than we currently anticipate, increasing the risk of falling below our inflation target.”

This viewpoint suggests the ECB may be falling behind in its rate-cutting strategies, supporting arguments for quicker interest rate reductions.

With inflation recorded at 2.2% in August, forecasts indicate it may rise again by the end of the year, only expected to return to the 2% target in late 2025.

On the other hand, conservative members—often referred to as hawks—argue that actual economic growth continues to exceed weak survey results and that the economy is holding steady. They highlight robust consumer spending, a successful tourism season, and a revival in construction as evidence of ongoing respectable growth.

Additionally, wage growth remains significantly above levels consistent with a 2% inflation target, suggesting that real incomes are rebounding quickly and will likely continue to support the economy. While the industrial sector faces challenges that could potentially lead Germany into a recession, many believe this is a structural issue that will take years to address, limiting the role of monetary policy.

These hawkish perspectives strengthen the case for gradual rate cuts, potentially one every quarter, until the ECB is confident that inflation will return to the target level. Hawks are also expected to resist any easing of policy that could delay reaching the inflation target into 2026, as this might undermine the ECB’s credibility.

ECB board member Isabel Schnabel, a notable policy conservative, emphasizes the importance of prioritizing inflation concerns over growth. In a recent speech, she stated, “Monetary policy should remain focused on bringing inflation back to our target in a timely manner. While risks to growth have increased, a soft landing still appears more likely than a recession.”

Moving forward, the existing rift is not expected to influence the upcoming policy decisions in September, as there is already considerable agreement on the need for rate cuts. However, it could affect how ECB President Christine Lagarde communicates the decision and sets expectations for the October meeting.

The bank is unlikely to abandon its "meeting by meeting" approach to policy setting, meaning no firm commitment regarding October’s decisions will be established. However, dovish members are urging Lagarde to emphasize growth risks and indicate that consecutive cuts are possible.

Hawks, however, caution that such messaging might overly increase market expectations, putting the ECB in a precarious position. Current market sentiment indicates a 40% to 50% chance of a rate cut in October, and a dovish tone could solidify these expectations.

Despite an agreement on the overall policy statement, Lagarde retains flexibility in her delivery, allowing her to emphasize specific points. Economists also hold a mixed outlook on the European economic situation, with many agreeing it remains challenging.

Even if the U.S. manages to avoid a recession, Europe might not share that fortune, according to strategist Thierry Wizman. He noted that weak demand from China for European exports exacerbates the downturn, and the rising far-right political sentiment in France and Germany may further dampen consumer confidence.

ABN Amro, meanwhile, anticipates continued but sluggish growth, noting, “The eurozone’s economic recovery is struggling to gain traction.” They pointed out that a high savings rate indicates consumers are cautious about spending any real income gains, particularly in countries like France, the Netherlands, and Germany.