Dovish ECB tone suggests more cuts to come

The tone in the statement and press conference was dovish. First of all, the Governing Council noted that ‘the outlook for growth has deteriorated owing to rising trade tensions’ and it also asserted that ‘downside risks to economic growth have increased’. Although ‘an increase in defence and infrastructure spending would add to growth’ the combination of ‘trade tensions and associated uncertainties’ and ‘deteriorating financial market sentiment’ as well as ‘geopolitical tensions’ seem to have been given more weight to skew the outlook further to the downside.

Second, the ECB sounded relatively sanguine about domestic inflationary pressures saying that ‘services inflation has also eased markedly’. Although the ECB remained non-committal on the impact of tariffs on inflation saying that ‘the net impact on inflation will only become clearer over time’ the factors it mentions pushing inflation down seem to be more powerful, concrete and timely than those that may push it up.

In particular, downside risks included ‘falling global energy prices and the appreciation of the euro’ as well as ‘a re-routing of exports into the euro area from countries with overcapacity’ as well as the negative impact of tariffs and tighter financial conditions on economic growth. On the upside, specifically in relation to the trade war, it only mentions that ‘a fragmentation of global supply chains could raise inflation by pushing up import prices’. While it also mentions fiscal policy as an upside risk, it is clear from its overall growth assessment that tariffs and tighter financial conditions will be the most significant factors for the economic outlook.

Third, it dropped its reference to ‘monetary policy …becoming meaningfully less restrictive’ that was introduced to the statement in March. At the time, that was seen as a sign that the ECB was getting closer to a neutral rate and that meant that the room for further rate cuts was limited. President Christine Lagarde explained that the previous statement was now ‘meaningless’ as neutral only works in a ‘shock-free world.’

Fourth, the decision to cut interest rates was unanimous. This is notable given that Ms Lagarde also noted that before the escalation of trade tensions, several Governing Council members were minded to keep interest rates on hold at this meeting. This also suggests that the reaction function to higher tariffs is lower interest rates.

So although the ECB continued to stress that ‘it will follow a data-dependent and meeting-by-meeting approach’ and that it is not ‘pre-committing to a particular rate path’, the tone of the statement and press conference are consistent with further rate cuts in our view. The June meeting – where the ECB will provide updated projections and will have a bit more clarity on all the drivers above – should provide more information on the future direction of policy. We continue to expect the deposit rate to be cut further. Overall, at the next three meetings, we expect 75bp of rate reductions, taking the ECB’s deposit rate to a low of 1.5% to be reached in September. The risks to this view are skewed towards more rate cuts.