News & Analysis

The ECB kept all policy rates unchanged once again in today’s decision, meeting both consensus expectations and our own pre-announcement call.

The language within the rate statement was also broadly unchanged, with the central bank noting that “key ECB interest rates are at levels that, maintained for a sufficiently long duration, will make a substantial contribution” to returning inflation to target. The main adjustment came in the updated staff forecasts, where downgrades were visible across all indicators. While weaker growth and headline inflation forecasts were expected, the downward revisions to 2025 and 2026 core inflation came as a dovish surprise to consensus. What was more surprising, however, was that the ECB deemed that it remains premature to take comfort in these updated forecasts, with President Lagarde noting that the Governing Council isn’t “sufficiently confident” to begin easing rates. Most of this uncertainty relates to the labour market, where policymakers will know “a little more in April” and “a lot more in June” according to Lagarde. This suggests that while the door remains open to an April cut, it is barely ajar.

Reflecting these developments, we now suspect the ECB will delay any decision to cut rates until June, noting the bar has been raised for upcoming growth and inflation data to force the ECB to cut rates earlier given the central bank’s unchanged guidance in the face of more sympathetic forecasts.

While we think the ECB will continue to cut rates at a pace of 25bps per meeting until the deposit rate reaches 2.5%, culminating in 125bps of cuts this year and a further cut in 2025 before a period of pause and reflection, the delayed commencement of the ECB’s easing cycle raises the risk of larger reductions in 24H2 when the bulk of this year’s disinflation should materialise.

ECB staff projections suggest the ECB should be gaining confidence to cut, but Lagarde says otherwise

Eurozone economic data has come in mixed since the ECB’s last meeting in January, with core inflation pressures estimated to have accelerated slightly, real-time wage metrics softening, and growth data undershooting expectations yet showing very premature signs of improvement. Nevertheless, the data has uniformly softened since December’s staff projections, while the outlook for energy, particularly natural gas prices, has become significantly less inflationary. This meant downgrades to the ECB’s growth and headline inflation forecasts were widely expected today.  Nevertheless, two things stood out to us within the latest round of projections. First, ECB staff now expect core inflation to cool at a much faster pace over the projection horizon, settling now at an average rate of 2% in 2026. This reflects improving supply chains, the fading of post-pandemic reopening effects, moderating second round effects from higher energy prices, and a greater monetary drag. Second, this view is conditioned on a EURIBOR curve that is around 0.2-0.4pp lower over the next three years relative to that used in December.

Together, this suggests that ECB staff believe more monetary tightening remains in the pipeline, which in isolation should provide greater confidence on the disinflation process than that alluded to by President Lagarde in the press conference.

Turning to growth, ECB staff downgraded their short-run expectations for GDP, reflecting weakness in forward looking indicators that remain in contractionary territory in the first two months of 2024. From the second half of 2024, however, growing real incomes are expected to propel a modest upturn. Given this, 2024 growth figures have seen a 0.2pp downgrade, with Bank staff now looking for just 0.6% GDP growth this year. But 2025 has been left unchanged, and 2026 actually received a 0.1pp upwards revision due to expectations for stronger private consumption that are now being projected.

This is broadly in line with our own expectations that look for weak growth in the first half of this year, before falling inflation and interest rates fuel a recovery in economic activity from Q3 onwards.

Despite the staff projections highlighting that the central bank now views the transmission of previous policy tightening as having a greater drag on the economy, especially as the weaker forecasts are conditioned on a lower EURIBOR rates curve, President Lagarde went to great lengths during today’s press conference to guide markets towards the June meeting as the most likely time for a cut, reiterating the need for further wage and profit margin data released after the April 11th decision.

Delay in easing risks larger cuts in 2H24 and prolonged euro weakness 

While the ECB’s approach may be viewed as prudent, it is set against a considerably weaker growth backdrop compared to the likes of the Fed. Therefore, in a similar vein to the Bank of Canada, the reluctance of the ECB to cut in advance of the Federal Reserve risks more pronounced economic weakness over the medium-term and a faster eventual easing cycle– an outcome Banque de France Governor Villeroy de Galhau recently warned against. This latent risk makes it difficult to turn structurally bullish on the euro over the medium-term, despite the ECB’s perceived hawkishness as the delay in easing may merely substitute near-term weakness from earlier sequencing for more pronounced medium-term underperformance.

The progression of growth data under these restrictive monetary conditions and the associated financial stability risks will be key in this regard moving into the second half of the year.

 

 

Author: 

Simon Harvey, Head of FX Analysis

 

 

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