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The European Central Bank has left interest rates on hold despite cutting its forecasts for inflation and growth, as the eurozone’s ailing economic outlook failed to convince policymakers that price pressures had been tamed.

The ECB maintained its benchmark deposit rate at an all-time high of 4 per cent at its meeting on Thursday. But it lowered its forecast for inflation this year from 2.7 per cent to 2.3 per cent, opening the door to possible rate cuts in the coming months.

The central bank also reduced its 2024 growth forecast for the fourth quarter in a row, saying it expected eurozone gross domestic product to rise just 0.6 per cent this year, down from its previous estimate of 0.8 per cent.

Even as the economy slows to a crawl, several rate-setters have expressed concern that rapid wage growth could keep inflation above the ECB’s 2 per cent target — particularly in the labour-intensive services sector. 

Underlining these worries, the ECB said it expected core inflation — which excludes volatile energy and food prices — to be 2.6 per cent this year, slightly lower than its previous forecast of 2.7 per cent.

“Although most measures of underlying inflation have eased further, domestic price pressures remain high, in part owing to strong growth in wages,” the ECB said in a statement, adding it would “ensure that policy rates will be set at sufficiently restrictive levels for as long as necessary”.

Eurozone government bonds rallied slightly after the ECB kept interest rates on hold, as expected. Yields on benchmark 10-year German Bunds — which were already down for the day — were 0.06 percentage points lower at 2.26 per cent after the announcement.

Rate-sensitive 2-year German bond yields were down 0.09 percentage points at 2.78 per cent. Yields move inversely to prices.

The ECB’s decision to leave rates on hold follows a similar move by the Canadian central bank on Wednesday and is expected to be mirrored by the US Federal Reserve and the Bank of England when they meet in two weeks’ time.

Investors have recently shifted their bets on when the central banks will start cutting borrowing costs from the spring to the summer.

The eurozone economy stagnated for much of last year and has been slower to recover from the double shock of the pandemic and Russia’s invasion of Ukraine than most advanced economies, in particular the US.

Inflation in the eurozone has dropped rapidly from its peak above 10 per cent to 2.6 per cent in February. Yet services inflation has come down more slowly from its record annual rate of 5.6 per cent last July to 3.9 per cent in February.

“Prices in the services sector are showing stickiness at levels that might not be consistent with the 2 per cent inflation goal,” said economists at UniCredit in a note, adding that they expected the ECB to start cutting rates in June but “with risks tilted towards a later start”.

The Bank for International Settlements, an umbrella body for central banks, said this week that if services prices kept rising rapidly, the “possible slowdown of disinflation could prompt monetary policy to remain tighter for longer”.

The ECB forecast inflation would slow to an average of 2 per cent next year, indicating rate-setters are becoming increasingly confident they will soon achieve their main objective. 

Yet some analysts worry policymakers’ focus on backward-looking data, particularly wages, means they may be too slow to cut rates and squeeze the already weak economy so much that inflation ends up falling below their target.

“The biggest risk to me is that they are not forward-looking enough and wait too long until they ease policy,” said Frederik Ducrozet, head of macroeconomic research at Pictet Wealth Management.

The ECB said it expected the eurozone economy to rebound next year “supported initially by consumption and later also by investment” as it forecast growth of 1.5 per cent in 2025 and 1.6 per cent the following year.

Additional reporting by Stephanie Stacey in London