ECB sticks with summer rate cut talk
ECB sticks with summer rate cut talk ECB decided to keep rates steady today, as was widely expected. The key takeaway from the press conference was Christine Lagarde who said that she stands by her summer rate cut comments last week in Davos. It is uncharacteristic for an ECB President to deliver a pre-commitment on rate cuts like this. The comments included in the press conference were at odds with the ECB statement, that said the ECB will ‘continue to take a data dependent approach’ to making decisions about monetary policy.
Signs grow that the ECB is moving to a loosening bias
The ECB cannot have it both ways: the President can’t say a rate cut will come in the summer, while also maintaining a data-driven approach to determining when to cut interest rates. Either Lagarde jumped the gun, possibly to annoy all those economists that she is forced to work with at the ECB, or the ECB moved to a loosening bias by stealth. We tend to think it is the latter, and there were clues within the statement accompanying the rate decision that the ECB is shifting its policy stance. Firstly, the ECB stated that ‘almost all measures of underlying inflation declined in December’ and she also said that the ‘disinflation process is at work’ in the Eurozone. Core inflation is what the ECB wants to target, so there is obviously a sense at the bank that rate hikes are working. The ECB has been particularly concerned about wage pressures, but even here there are signs of improvement, and a disinflationary trend could be starting. The ECB said that although wage inflation remains high, and lower productivity levels are keeping pressure on wage growth, both are showing signs of easing. Importantly for the ECB, inflation expectations have ‘come down markedly’ in the short term, and long-term inflation expectations remain around 2%.
Weak growth prospects and signs of lower wage inflation boost ECB rate cut hopes
Regarding growth, it is hard to talk up the Eurozone’s growth prospects, and Christine Lagarde said that the Eurozone economy most likely stagnated in Q4, even though the data does not come out for another 3 weeks. She said that the growth rate would pick up at some point in the future, at the same time as the ECB expects unemployment to rise. The ECB also pointed to global trade tensions as a threat to European growth.
Europe’s threat from Trump
This could become a real danger if Donald Trump wins the Presidential election in November. He has threatened to put a blanket tariff of 10% on all imports. While there is a risk that this could negatively impact the US economy, it is highly likely that it would hit the Eurozone economy hard, due to the importance of the US as a destination for European exports. Thus, the political drama playing out in the US also needs to feed into the ECB’s monetary policy decisions in the coming months.
The ECB mentioned that tensions in the Middle East and the Red Sea could have a negative impact on the current disinflation trend. However, it is worth noting that this would most likely impact headline inflation, and not core or underlying inflation, which is what the ECB targets. There would not necessarily be a big passthrough from higher headline inflation to core if the Eurozone economy slows as expected this year.
The market impact
Thus, on balance, we think that unless the economic data starts to defy gloomy forecasts, then the stage is set for rate cuts later this year. Markets are flat on the back of this statement, as the ECB didn’t materially change their message. Today’s meeting is supportive of the recent recovery in European stocks and could weigh on the euro in the short term. The bond market is taking today’s meeting as a sign of a dovish bias at the ECB. The German 2-year government bond yield fell 8 basis points after this meeting, and it has stabilized around the lows of the day as we move to the European close.