Investment Institute
Market Alerts

ECB: Towards a (very) informed first rate cut in June

  • 07 March 2024 (5 min read)
ECB Governing Council (GC) kept all its policy rates unchanged - depo rate remains at 4% as widely expected.
ECB GC needs more data to be reassured about domestic disinflation and with it the upcoming easing cycle. These are likely to help generating a convergence of views within the GC.
Two assumptions made by ECB staff need close monitoring: pick-up in labour productivity and profits absorbing increased labour costs, likely playing a key role in ECB’s marked downward core inflation revisions.
Growth forecast and inflation have been revised down. Inflation more so than expected, such that ever so slight asymmetry around 2% is now visible. Crucially, timing to hit 2% is unchanged at H2 2025.
We continue to expect the first rate cut to occur in June. Market pricing has converged for June but has slightly more dovish view pricing 95bps worth of cuts, more than our 75bps in total this year.
Short and long end EUR rates ended where they were prior to meeting. We are surprised by strong EURUSD market reaction.

A decision free meeting as widely expected

ECB GC decided to leave all its policy rates unchanged, thus keeping its depo rate at 4% for a fourth consecutive meeting. Decision was widely expected across market participants and unanimous as reported by Christine Lagarde during the press conference. During the latter, she confirmed the Reuters story from last week, expecting the ECB to communicate on its revised operational framework on 13th March. We do not expect this will have significant ramifications for the monetary policy stance in the short-term.

More data needed to ascertain domestic disinflation

Elaborating from a fairly neutral monetary policy statement – slightly lower than expected projected inflation path broadly offset by domestic inflation making its comeback (absent in January) and qualified as “remaining high” - President Lagarde hammered two clear messages during the press conference. First, “we need more evidence to come in the next few months. We will have a bit more in April, a lot more in June”. The ECB is looking for additional data to be sufficiently confident on the inflation landing sustainably at 2%. Second, more data is especially needed on domestic (basically services) inflation, having not shown sufficient disinflationary path. While wage growth is a key determinant of domestic inflation, and for good measure taking prominent space during the Q&A, we think it is rather the combined observations of wage and profit growth (mentioned much fewer times) that holds the key. Crucially, these are only released on a quarterly frequency on the final release of GDP estimates – tomorrow for Q4 23. Furthermore, she mentioned that latest ECB staff forecast have made the implicit assumption that profits will absorb increased labour costs. These were top of our list, as mentioned in our preview.

Happy with market pricing, divided GC in the background

President Lagarde carefully stayed clear on looking to guide market expectations, though could not resist saying ”it seems to be converging better”. In the same vein, she specified that rate cuts were not discussed at this meeting though “what we have done, we have just begun discussing the dialling back of the restrictive stance”. We draw two takeaways from such a crafted sentence. First, the first rate cut is an important, though may not be just as a crucial decision, than the path, the guidance that the GC will have to give, at the time of the first cut, for the easing cycle - beyond data dependency. Second, division lies within the GC. Besides today’s unanimous decision, President Lagarde highlighted very broad agreement that GC needs more evidence, but likely remains divided on timing of first cut and the forthcoming easing cycle, and its communication.

ECB staff revised down GDP growth broadly in line with our expectations. Two key assumptions to monitor. 

This year’s GDP growth was revised down 0.2pp in line with our expectations, closer to our own forecasts (AXA IM: 0.3%). Furthermore, President Lagarde mentioned in the press conference that risks to the growth outlook remain titled to the downside. 2025 was unrevised at 1.5% (optimistic compared with our unrevised 0.8%), which together with upwardly revised (+0.1pp to 1.6%) are well above potential. Taken together with only small adjustments in projected employment growth implies that ECB staff has kept their strong pick-up productivity assumption “which should support the moderation in labour costs pressures”. Another key assumption in ECB staff scenario is abovementioned expectations that profit growth is expected to weaken “and provide a buffer to the pass-through of labour costs”. 

Stronger-than-expected downward inflation revision. Though timing hitting 2% is unchanged in H2 25, we note ever slight asymmetry around 2%. 

Beyond the downside revisions to both headline (-0.4pp, mainly owing to energy) and core inflation (-0.1pp) to 2.3% and 2.6% – slightly below our 2.5% and 2.7% - respectively for this year, we think the abovementioned assumptions are instrumental in a cumulative (surprisingly large) 0.3pp downward revision in core inflation until 2026: -0.2pp to 2.1% in 2025 and -0.1pp to 2.0% in 2026. As we expected in our preview, the time at which headline inflation is projected to hit the ECB 2% inflation target is unchanged from December (H2 2025), justifying the unchanged, broadly neutral policy stance. However, instead of hitting just 2% as pencilled in December, it is now due to hit 1.9% y/y in both Q3 and Q4 2025, and even reach 1.8% y/y in Q1 2026, before edging up to 1.9% y/y in the remainder of 2026 (unchanged from December), a worth highlighting ever so slight asymmetry.

We stick to our long-held June rate cut call. 

As explicitly mentioned in today’s meeting, the following GC meeting being just four weeks away (11 April), we do not think the ECB will have received enough to data to be sufficiently confident on domestic price pressures. It would take quite a suite of events (Fed dovish turn, sharp downside surprise in March flash inflation print, adverse shock to affect growth outlook) to force the ECB starting its cutting cycle without these additional data and without updated forecasts to help with the communication on the easing cycle. In turn, we reaffirm our long-held call of a 25bp rate cut in June, expecting three in total this year.

Markets reaction - Status quo in rates, higher EUR and equities.

After an initial rally in rates and drop of the EURUSD, in the wake of the introductory statement, probably owing to the more significant than expected downside revision in inflation forecasts, both short and long end rates sold off, very close to their levels pre-meeting (c.95bps rate cuts priced by Dec-24, and 10y bund at 2.30%). Meanwhile, the EUR remained more aggressively bid ending higher towards 1.093, so were equities. We find the EURUSD reaction a bit surprising after President Lagarde very clear comments that the ECB will act independently from the Fed "do what we have to do it when we have to do it".

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