The ECB's Summer Love

Yet they judge that data is moving in the right direction and rate cuts are likely to come in the summer. Most importantly and explicitly, ECB President Christine Lagarde was asked in an Bloomberg interview at Davos whether there could be a majority on the Governing Council in support for a rate cut this Summer. She responded that she ‘would say it’s likely’ but that she had to be reserved, because the ECB is ‘data dependent’. A few days earlier, Chief Economist Philip Lane gave some insights into the possible summer timing. In an interview with Corriere della Sera, he noted that the ECB wanted to see clear signs that pay settlements and wage growth more generally were decelerating. Mr Lane asserted that ‘by (the) June meeting, we will have those important data’.  The comments of a string of ECB officials have been clearly designed – as well as co-ordinated - to bring down market expectations of early cuts in policy rates. Ms Lagarde asserted that ‘it is not helping our fight against inflation, if the anticipation (of rate cuts) is such that they are way too high compared with what’s likely to happen’. Klaas Knot, Governor of Dutch central bank, stuck with the same theme in an interview with CNBC noting that ‘markets are getting ahead of themselves, it’s pretty clear, and the problem for us is that in the end that might become self-defeating’ as the ECB’s inflation projection is based on an interest-rate path that has ‘significantly less easing than is currently embedded in market pricing’. The idea being that the easing of financial conditions driven by pricing of too early rate cuts could slow disinflation.  Our base scenario is that the ECB will cut interest rates by 25bp in June. Although the comments of ECB officials reduced rate cut pricing, markets continued to price in a significant probability of a rate cut at the April Governing Council meeting. At the time of writing, 20bp was priced, though that is down from 40bp at the start of this year. Given this, we think that some further correction is likely as the bar in terms of data (much weaker activity and inflation) to trigger an April rate cut is very high. Looking further out, we think that once the rate cut cycle starts, it is likely to be more extensive than markets currently price, with the deposit rate eventually being reduced to 1.5%.