The ECB is widely expected to deliver a 25bp rate cut at its meeting on Thursday. This is largely because the bank’s Governing Council members have stated as much. We also get the latest updated June staff economic projections that are predicted to suggest that the prevailing economic and monetary policy narrative stays broadly unchanged. That means this rate cut will be seen as a rollback of the ‘insurance hike’ from September last year. Key for markets will be what happens next, and any guidance given by Lagarde & Co.
As was likely, the ECB kept all key rates on hold in the April meeting, with the deposit rate at 4.0% for the fifth consecutive meeting. The statement was altered again to offer yet another clear steer that the Governing Council will look to begin cutting rates in June. It said if the bank’s “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”.
Inflation data helps the hawks
But the May inflation data serves as a warning that this week might not mark the start of a traditional cutting cycle. It ticked up both in the headline and the crucial core prints. That said, the latter seems set to decelerate again, but the question is at what pace and what if it ticks up again? Doubts about the future inflation path will aid the hawks’ arguments on the Governing Council. In addition, while many forward-looking indicators remain benign, a hot labour market, continued supply chain disturbances, and a recovery of purchasing power will all make for an interesting debate at the ECB as it decides on the path of monetary policy from here.
Ultimately, Thursday should see policymakers retain an easing bias, but without being specific on when it might cut rates further whilst reaffirming its data dependence. We will hear the latter phrase no doubt numerous times. “Cautious and gradual” are the other watchwords with President Lagarde earning her corn in the press conference in trying to balance up all the competing sides of hawks and doves. We will also be on watch for “sources” comments after the meeting. Generally, the sooner these are released, the more disharmony there is on the Governing Council.
Market reaction
Markets have nothing extra priced for 18 July meeting and just over half of another 25bps cut priced for September. That means there is scope for the near-term forward rate path to be impacted by the bank’s and President Lagarde’s guidance.
EUR/USD ticked up above 1.09 briefly earlier this week as the economic data brightened modestly in the region. A lack of guidance by the ECB could be read as a hawkish signal and give some support to the euro in the short term. However, the fact that the ECB has moved before the Fed, who are battling higher inflation and wages, should make markets quite comfortable with jumping back into pricing in two more cuts in 2024 (after the June move).
