ECB Set to Cut Rates for First Time Since 2019 Amid Inflation Concerns

ECB Set to Cut Rates for First Time Since 2019 Amid Inflation Concerns 

Following the Bank of Canada's (BoC) recent decision to cut rates by 25 basis points, the European Central Bank (ECB) is anticipated to reduce the deposit rate from 4.00% to 3.75% for the first time since September 2019. Market analysts give a 94% probability to this outcome. With the rate cut almost certain, attention will shift to any indications of future rate cuts, although markets don't fully expect another move until December. Changes to staff projections are expected to be minor. Bank of America strategists also foresee a 25bps cut and predict further reductions by mid-2025, maintaining a meeting-by-meeting approach dependent on data. Small forecast adjustments upwards for 2024/25 are likely, but core inflation at 2% in 2026 should stay, suggesting a possible cut in September if data supports it.

In the rates markets, a cut by the ECB on Thursday is fully anticipated, with forward pricing reflecting nearly a 25bp reduction. ING Economics points out that the focus remains on the outlook beyond June. A consecutive cut in July seems unlikely, with markets estimating only a

10% chance. A second cut is almost fully priced in by October, but a third cut this year is still uncertain. External factors, like weaker US data and falling oil prices, have contributed to lower rates in the eurozone. While the market leans towards a three-cut scenario for this year, recent domestic data on wages and CPI suggest a more cautious approach at the upcoming meeting.

Markets might adjust higher, but they will likely remain in the two to three-cuts scenario unless new data provides clearer direction. This uncertainty will affect the longer end of the yield curve, influenced by US economic data. The trajectory of the 10-year Bund yield, potentially surpassing 2.6%, will depend on the ECB's hawkishness.

According to Newsquawk, here are key points ahead of the ECB's expected rate cut, their first in five years:

Previous Meeting: The ECB maintained rates as expected, reiterating that they will keep rates sufficiently restrictive for a sufficiently long period, with a data-dependent, meeting-by-meeting approach. New in the statement was a note that reducing monetary policy restriction could be appropriate if inflation trends towards the target. President Lagarde mentioned they would have more data by June to inform decisions. Some policymakers considered a second cut in July to sway those favoring an earlier start.

Recent Economic Developments: Inflation rose to 2.6% in May from 2.4%, with the core measure increasing to 2.9%. The ECB's survey showed a slight decrease in 12-month inflation expectations to 2.9%. Market indicators like the 5y5y forward inched up from 2.35% to 2.36%. Eurozone wages grew by 4.69% in Q1, and Q1 GDP rose to 0.3% from 0.0%. The EZ-composite PMI moved further into expansionary territory, suggesting 0.3% growth in Q2, while unemployment remained at a historic low of 6.4%.

Recent Communications: President Lagarde signaled a rate cut soon, barring major surprises, expressing confidence in controlling inflation. Chief Economist Lane warned that keeping rates too high for too long could necessitate corrective action. Thought-leader Schnabel cautioned against rapid rate changes due to persistent inflation elements, while hawkish members like Austria's Holzmann advocated for pausing in July. Dovish members like Italy's Panetta and Greece's Stournaras favored timely and small cuts to address weak demand.

Rates: The ECB is expected to lower the deposit rate from 4.0% to 3.75%, with markets assigning a 94% probability to this outcome. The debate within the Governing Council will focus on future rate cuts, with hawks likely advocating a pause in July due to emerging inflation risks, and doves arguing against overly restrictive policy. The policy statement's hints at further actions will be scrutinized, with another cut not fully priced in until December.

Macro Projections: ING expects slight upward revisions for growth and inflation for this year, but no changes to the timing of inflation falling below 2%. Risks of persistent inflation are noted, with projections as follows:

HICP Inflation:

2024: 2.3% (expected 2.4%)

2025: 2.0% (expected 2.1%)

2026: 1.9% (expected 2.0%)

HICP Core Inflation (Excluding Energy & Food):

2024: 2.6%

2025: 2.1%

2026: 2.0%

GDP:

2024: 0.6% (expected 0.7%)

2025: 1.5% (expected 1.4%)

2026: 1.6% (expected 1.4%)

Finally, ING provides a scenario analysis for positioning based on these various outcomes.