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Markets, central bank disagree on interest rate cuts

Euros.
Euros. Source: Siim Lõvi/ERR

The financial markets expect Euro area interest rates to fall this year, but members of the Council of the European Central Bank warn expectations are too optimistic as inflation is still well above 2 percent.

On Tuesday, "Aktuaalne kaamera" asked experts what the coming year may bring.

Economic analyst Peeter Koppel said there are many confusing signals on the markets and no clarity about which direction the economy will move in.

However, the financial markets expect the Eurozone base interest rate to drop to 2.5 percent this year.

"The markets are betting in real terms that at the end of the year we will be talking about interest rates at 2.5. Obviously, the central bank does not like this market expectation very much and it does not seem realistic, and that is why they are trying to lower these expectations with their rhetoric," said Koppel.

Governor of the Bank of Estonia Madis Müller said: "Given that the interest rate today is 4 percent, 2.5 [percent] by the end of the year is, I think, quite an aggressive expectation."

Peter Priisalm, head of asset manager Avaron's investments, said: "By the end of the year, the market has estimated that interest rates will fall by around 1.5 percent. It will certainly depend very much on how strong wage growth is, which is certainly supportive of inflation, and how strong the economy is. If the economy were to go into a sudden downturn, the central bank would certainly be ready to cut interest rates more quickly, and to do so in 0.5 percent steps at a pretty rapid pace."

Müller's colleague from the Austrian National Bank warned on Monday that no interest rate cuts should be expected this year. Müller said inflation should drop closer to 2 percent.

"One thing to at least look forward to is how wage growth in the Euro area as a whole will evolve. We can see that wage growth has slowed in Estonia, but not yet so clearly in the Euro area. According to the latest data, average wages are rising at a rate of around 5 percent in Europe as a whole, which, if it stays at this rate, is not quite in line with the 2 percent rise in prices," said Müller.

The six-month Euribor, which is related to interest on home loans, has already dropped from its peak and this change should be reflected in loan payments in the near future.

"Expectations have already been raised for a drop in Euribor. If all goes according to plan, interest rates could come down in April. We will see in a few months if this is the case," said Anne Pärgma, head of Housing Loans at Swedbank.

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Editor: Marko Tooming, Helen Wright

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