ECB building to an April pause, but shocks will determine outlook
The ECB cut its key policy rates by another 25bp as was widely expected, taking the key deposit rate to 2.5%. In a sign that the Governing Council judges that interest rates are closer to neutral it noted that ‘monetary policy is becoming meaningfully less restrictive, as the interest rate cuts are making new borrowing less expensive for firms and households and loan growth is picking up’. However, there were also clear signs that it does not see the job done quite yet.
It noted that ‘lending remains subdued overall’ and also that ‘the economy faces continued challenges’. Indeed, it again reduced its growth forecasts. The main downgrade came on exports. Although the tariffs are unlikely to be factored into its forecasts, it was incorporating the impact of ‘high trade policy uncertainty’. Meanwhile, it remained confident on inflation, saying that the ‘disinflation process is well on track’ despite some upward revision to inflation projections, mainly due to energy prices (which have since fallen sharply after the cut-off date for these forecasts, as Lagarde acknowledged in the press conference). However, crucially ‘most measures of underlying inflation suggest that inflation will settle at around the Governing Council’s 2% medium-term target on a sustained basis’.
In the press conference, Lagarde was repeatedly asked if she still thought the ‘direction is clear’, as she had previously claimed. She refused to answer this question directly, only to state her three main observations guiding policy at the moment: 1) disinflation is on track; 2) monetary policy is less restrictive, 3) there is ‘phenomenal uncertainty’ with ‘risks all over’. She pointed to upside risks from recent fiscal developments in Germany and more broadly defence spending, but like us she noted that much would depend on the timing and composition of spending (see ). At the same time, trade policy is clearly posing downside risks. Lagarde continued to point to ‘data’ as the determinant of a pause or cut at the next meeting, which does not make a great deal of sense, when the main driver right now is policy – not data – uncertainty.
Reading between the lines, we think the Governing Council is building towards an April pause – something we had for a while expected but the precise timing for which we did not have great conviction over. At today’s meeting Austrian central bank governor and arch hawk Holzmann abstained from the decision to cut rates. While his abstention is not surprising given his track record, the recent news on the fiscal front is likely to encourage more hawks to oppose near term cuts. Even if the US administration forges ahead with massive tariffs in early April, the uncertainty over negotiations, retaliation and impact will probably stay the ECB’s hand at this meeting. Instead, we think the next rate cut is likely to come when staff next update their projections at the June meeting. Looking further ahead, and despite the risks pulling in both directions, we think the balance is still tilted to the downside, and that the ECB will likely cut rates more significantly than markets expect. (Nick Kounis, Bill Diviney, Jan-Paul van de Kerke)