ECB likely content with current market pricing
The ECB Governing Council’s meeting this week takes place against the background of market pricing for rate cuts having been scaled back significantly. Only 5bp is now priced in for April, while markets just fall short of factoring in a full rate cut for the June meeting (23bp). Given that most officials seem to be coalescing around a start to the easing cycle in June, the Governing Council is likely content with current market pricing. Therefore, the aim of communication following the end of the meeting will likely try to not rock the boat one way or the other. There is a risk that downward revisions to the ECB macro staff projections (see below) could fuel expectations of an earlier move. However, President Christine Lagarde should be able to easily counter these by emphasising that the central bank wants to see more evidence that domestic inflationary pressures are abating.
Domestic inflation is key - This would involve three key elements. First, evidence that wage inflation is trending to around 4.5% this year. Although that would be above the roughly 3% consistent with the 2% medium term target, it would be acceptable given that it would be heading in the right direction and given developments the ECB expects in profit margins. Indeed, the second element officials want to see is signs that companies are absorbing excessive labour cost growth rather than passing it on in price rises. Finally, ongoing signs of disinflation in services. We think we will see all three of these elements going in the right direction as weak demand and second round effects from lower energy prices continue to feed through.
Once easing start, markets may price more cuts - Our base scenario is that the ECB will cut rates by 25bp in June, which is broadly in line with current market pricing. We think that after that, 25bp rate reductions will follow at each of the remaining policy meetings of this year, meaning a cumulative 125bp in rate cuts in 2024. We would still see this as a gradual normalisation given that the policy rate would still be at restrictive levels at the end of this year. However, financial markets are pricing in a slower pace of rate cuts after June, with cumulative rate reductions of around 90bp for this year. We therefore think that once the ECB starts to cut rates and it becomes clearer that it will move again at the next meeting, there is substantial room for more rate cuts to be priced in.
ECB to revise projections for growth and inflation in 2024 lower - In its December projections, the ECB expected GDP to expand by 0.8% in 2024 and by 1.5% in both 2025 and 2026. We think that the forecast for 2024 will be revised lower and the ones for 2025 and 2026 will remain broadly unchanged. To begin with, actual GDP growth in 2023Q4 came in below the ECB’s projections (at 0.0% versus the ECB’s projection of +0.1%). Moreover, the ECB’s projection for 2024Q1 (0.2% qoq) also seems to be too optimistic, based on the incoming data and survey results for December-February. However, we do not expect a large downward revision to the growth forecasts further out as financial conditions have eased somewhat since the previous ECB meeting in December.
The ECB’s inflation forecasts for 2024 are expected to be revised somewhat lower as well. We expect no major revisions to the forecasts for 2025 and 2026. Moreover, we expect downward revisions to the headline inflation rate in 2024 to be more noticeable than downward revisions to the core rate. In December, the central bank forecast headline inflation to be 2.7% in 2024, 2.1% in 2025 and 1.9% in 2026 (core inflation: 2.7%, 2.3% and 2.1%, respectively). Actual inflation in January and February 2024 (2.8% and 2.6%, respectively) was well below the 2.9% average the ECB projects for 2024Q1. On top of that, natural gas prices and non-energy commodity prices have fallen noticeably compared to the technical assumptions that were made at the December inflation projections, whereas oil prices and EUR/USD are in line with the ECB’s assumptions.