Economists are dialling back their expectations for how far the European Central Bank (ECB) will lower interest rates after it starts cutting next week, according to a Bloomberg survey.
Respondents anticipate that the first of six quarter-point reductions in the deposit rate – currently at 4 per cent – will be announced next week. That’s one step less than they predicted before the Governing Council last set policy in April.
Since then, officials led by President Christine Lagarde have fortified expectations of a June cut that would see ECB move before the US Federal Reserve and the Bank of England. But a surprisingly robust rebound in Europe’s economy, sticky wage pressures and upside risks to an already uncertain inflation outlook are fuelling debate over subsequent steps.
Hawks such as executive board member Isabel Schnabel and Bundesbank president Joachim Nagel want to wait until September before considering a second move, and economists reckon a hesitant Fed will limit the ECB’s room to manoeuvre.
Communicating the ECB’s intentions without locking in a specific scenario may – once again – be the biggest challenge for Lagarde.
“It will be hard to argue why they’re so confident this is the right time to cut while not providing any guidance for further cuts,” said Hugo Le Damany, an economist at AXA Investment Managers. He sees the ECB halting monetary easing next June after just five steps and with the deposit rate at 2.75 per cent.
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Respondents still deem inflation to be the biggest risk to the euro-zone economy, followed by the fallout from the US presidential election and geopolitical tensions.
Inflation probably quickened a touch in May after two months at 2.4 per cent. Looking under the hood, wage growth unexpectedly failed to ease at the start of 2024, boosting pressure on services prices that continue to rise at a pace of almost 4 per cent.
In such an environment, three-quarters of those surveyed do not expect the ECB to offer any kind of guidance from one policy meeting to the next – especially because officials have vowed to pay particular attention to quarterly economic projections.
About 84 per cent of economists say such a focus makes rate moves every three months more likely, though 92 per cent say that does not exclude action in between. Underscoring just that possibility, France’s Francois Villeroy de Galhau has warned against discounting another rate cut in July.
This time around, survey respondents do not anticipate revisions to the ECB’s projections – aside from an increase in the 2024 outlook for economic expansion following a better-than-envisaged first quarter.
“We expect divergences among the doves and the hawks in the Council to emerge, with the former keen to remove all policy restrictions and the latter wanting to move cautiously until they feel confident that inflation is under control,” said Fabio Balboni, an economist at HSBC.
“That might make it hard for the ECB to provide any steer about the future path for rates beyond the present meeting, which could contribute to create uncertainty and volatility in the market,” he said.
Traders have pared bets recently on how many rate cuts they expect the ECB to deliver this year. They are now fully pricing two moves and one-in-three odds of a third, compared with just one reduction with a 20 per cent chance of a second for the US.
While inflation across the Atlantic has cooled substantially, progress has slowed. That’s sparked talk that US borrowing costs may need to stay high for longer – and speculation about what that would mean for Europe.
Almost three-quarters of respondents say the eurozone has its own inflation dynamic and is not simply trailing the US. Still, only 6 per cent say the ECB can fully decouple from the Fed in setting rates.
About 85 per cent reckon the ECB will have to keep rates higher than it would otherwise if the Fed delays easing, to counter inflation pressures from a weaker euro. Most economists say the ECB can cut three times should the Fed stand pat.
Europe may, in fact, be showing similar trends to those holding back Fed loosening, according to Nomura’s Andrzej Szczepaniak.
“With stronger activity data, resilient demand, an encouraging labour market, stronger-than-expected wage growth, and still sticky services inflation, we believe the ECB will end up cutting only gradually in order to maintain some level of monetary restrictiveness,” he said. “Cutting too much too quickly will unnecessarily refuel the embers of inflation and undo the ECB’s hard-fought battle.” BLOOMBERG
