ECB starts talking rate cuts
The ECB kept its key policy rates on hold as expected. In the press release, it talked about rate cuts explicitly for the first time. It noted that if its ‘updated assessment of the inflation outlook, the dynamics of underlying inflation and the strength of monetary policy transmission were to further increase its confidence that inflation is converging to the target in a sustained manner, it would be appropriate to reduce the current level of monetary policy restriction’.
These conditions seem to be already largely met. The ECB’s March inflation projection already showed inflation somewhat undershooting the target over the medium term and the press release confirmed that ‘incoming information has broadly confirmed the Governing Council’s previous assessment of the medium-term inflation outlook’.
At the same time, the press release also talked constructively about recent inflation dynamics noting that ‘most measures of underlying inflation are easing, wage growth is gradually moderating, and firms are absorbing part of the rise in labour costs in their profits’. Furthermore the statement asserted that ‘financing conditions remain restrictive and the past interest rate increases continue to weigh on demand’.
The one cloud in the assessment was that ‘domestic price pressures are strong and are keeping services price inflation high’. However, we judge that if the ECB is getting more confident on wages, then this would not be a barrier to rate cuts. Indeed in the press conference, Ms Lagarde also seemed to play down the importance of particular components, saying ‘we are not going to wait until everything goes back to 2%’ when asked particularly about whether high services inflation would be an issue.
Against the background of higher US inflation readings and the scaling back of Fed rate cut expectations, the ECB President made it clear that the ECB was willing to follow its own path. She asserted that while the Governing Council would be ‘data dependent’ it was ‘not Fed dependent’.
Overall, we think the ECB’s communication is consistent with a start of a rate cut cycle at the June Governing Council meeting. A large majority of officials seemed to be minded to support a June rate cut and the ‘few’ that did not thought that the data already justified a decision at this meeting. Looking further forward, the ECB would not pre-commit ‘to a particular rate path’ but would ‘follow a data-dependent and meeting-by-meeting approach’.
Our own base case is that the ECB will cut policy rates at each and every meeting from June onwards. We take the view that interest rates are currently deeply in restrictive territory. Estimates of the neutral rate are half or less than the current level of the deposit rate. Given that the eurozone economy has been stagnating for more than a year, the only justification for restrictive monetary policy has been above-target inflation. However, the inflation picture is changing fast. Even assuming 125bp of rate cuts this year, monetary policy would still be restrictive at the end of 2024.