ECB towards a new pause on rates, but the arrival of the first cut is complicated

“The situation is such that it requires a particularly high concentration on inflation before anything else.” The words of a senior official of the European Central Bank (ECB), a few days before the Governing Council meeting next Thursday, suggest what Frankfurt’s priority is. While international investors focus on the first interest rate cut, the ECB prefers to take more time. First the data, then the decisions. Especially because the persistence of inflation in the services segment is still marked. And, since there is a twist in the relationship between wages and prices, it is better to proceed with caution. This is why it is legitimate to expect that there will be no moves until, at least, June.

Financial markets are calling for substantial cuts in the cost of money to prevent the eurozone slowdown from turning into a recession. A scenario avoided last year, but which could materialize during 2024, according to more than one analyst. The president of the ECB, Christine Lagarde, excludes it. And indeed you see a rebound in the second half of the year. In the face of increasingly stubborn price increases that need to be kept under control, explains the ECB, the urgency is to keep the bar straight in view of new sets of data that can draw a more exhaustive map of the evolution of the prices of individual products in the entire eurozone. The president of the Bundesbank, Joachim Nagel, also said this: “The price outlook is not yet clear.” Of course, general inflation slowed further for the euro area, falling to 2.6% in February, two decimals lower than the year-on-year increase recorded in the previous month. But not only was the reading worse than analysts’ expectations. The “core” figure, therefore excluding energy and food, is still above 3 percent. In particular, more than one central banker is sure that there is still work to be done regarding the services segment, which in February was at +3.9 percent. Too much, considering the 450 basis points of increases from July 2022 to today.

The transmission of monetary policy, as highlighted in recent weeks by the German member of the Board, Isabel Schnabel, is still solid. And above all, you remarked while speaking at Bocconi University, “there is no evidence of a spiral between prices and wages”. At the same time, there are a large number of governors who see deflation proceeding steadily and sustainably. This is why, according to the more accommodating wing of Frankfurt, it would already be possible to introduce the first elements of discussion on a reduction in the cost of money at next week’s meeting. “It is difficult to go into depth, just as it is complicated that some governor can ask to speak openly about rate cuts by talking about a specific date,” explain three different internal ECB sources upon request of anonymity. However, officials do not exclude that there may be “some requests for clarification on the ECB’s path, and therefore on the next moves”. An unlikely scenario, but not impossible.

At the same time, the most significant debate on the markets concerns the contents to be brought to the last meeting before the summer. Investors give a 73% probability of a first quarter-point rate cut by the ECB on June 6, while the probability drops significantly in April (16.7%) and is slim for March (5.4%). ). The result of the implicit rates on which the markets are betting, collected on Bloomberg terminals on the basis of Overnight Index Swaps (Ois) derivative contracts, could however be revised in light of the next macroeconomic forecasts. If underlying inflation were to last longer than expected, if there were no repercussions on the real economy, if there were to be no rise in wages, and if deflation were to continue in a – more or less – homogeneous manner throughout the world eurozone, then there could be a change of direction. That is to say, the consolidation of the hypothesis of a cut already in June. So, sooner than the market imagines from the US Federal Reserve.

The problem is, as Nagel recalled, that there are no certainties. The only possibility, according to Lagarde, is to wait, while maintaining price stability as a priority. “We will continue to follow a data-dependent approach to determine the appropriate level and duration of the restriction, taking into account the inflation outlook, the dynamics of underlying inflation and the transmission strength of monetary policy,” the French central banker explained to European Parliament. There is no evidence, at least for March and April, that there will be a significant deviation from this path.

The next battle could be over the date of the first rate cut. A growing group of financial analysts, led by ING and Allianz, sees the initial decline in July, by 25 basis points. There is no prejudice in reducing the cost of money earlier than the US Fed, especially because the employment dynamics and the price formation mechanism are very different. What matters, according to Frankfurt, is the correct reading of the transmission mechanism of monetary policy. A mantra that only time, net of the consequences of ongoing geopolitical tensions, will tell if it will manage to prevent the economic slowdown from turning into something more severe.