ECB Preview (Mar 7): Caution Still the Council Watchword
Once again the ECB meeting verdict due next Thursday (Mar 7) will be notable not for what the Council does (save for downward tweaks to its projections (Figure 1)) but rather what is said. A fourth successive stable policy decision is unambiguously expected. This will come alongside a reaffirmation that pointing to rates being at levels that maintained for a sufficiently long duration will return inflation to target and that policy rates being at sufficiently restrictive levels for as long as necessary. But ‘sufficiently long’ and ‘as long as necessary’ remain vague and thus does provide the ECB some policy flexibility to be as data dependent as it will again boast it is. Last time around, the Council regarded to it premature to discuss easing, but this was only by consensus, implying a minority wanted such a debate. That minority may be larger and more vocal this time. They may even be persuasive enough to leave open the possibility of the first cut at the April meeting, albeit with the majority leaning more to the first move not before June and perhaps more explicitly so, possibly citing alleged evidence of economic recovery and price resilience.
Figure 1: Forecasts in Perspective
Source: Bloomberg, ECB, Continuum Economics
Modest Forecast Downgrade Expected
As Figure 1 highlights, existing ECB GDP projections look somewhat optimistic, especially for this year. This has been partly accepted as the account of the January 24-25 ECB Council meeting was interesting in anticipating some downward revision to growth and inflation projections at this looming Mar 7 meeting, most likely it deferring the anticipated timing of a recovery in GDP. While the discussion also very much focused on the importance of wage developments and possible labor hoarding in assessing the inflation outlook, it also noted that wages are far from the whole story in this regard. As for inflation, it was seen to have fallen faster and perhaps more broadly both on an underlying and price persistence basis. This latter line of thinking may have changed since, given what were somewhat disappointing HICP data for February.
Services Inflation Troubling the Hawks Still?
Admittedly, the headline, at 2.6%, continued its recent decline while the latest core is still on course to meet the ECB Q1 projection of 3.1%, if not undershoot it, with the headline much more likely to undershoot. But the ECB hawks has been somewhat troubled by the failure of services inflation to have fallen in the last few months, and the fact that it slowed just a notch to 3.9% y/y in February may harden those worries about aspects of price resilience not least as monthly adjusted numbers (Figure 2) have also shown some fresh resilience. The February data, at least in terms of recent HICP swings, do not accentuate the case for an immediate rate cut.
Figure 2: Eurozone Disinflation: Stalling, Slowing or Reversing?
Source, CE, ECB
ECB Reluctant to Trim Medium Term Inflation Outlook Further
As for the inflation outlook, it is notable that the ECB already envisages inflation at target by H2 next year and then settling a notch below through 2026. With this in mind (the ECB staff alone will prepare the projections this time rather than in unison with the Eurosystem central banks as was the case in December) may be reluctant to point to an earlier and or larger undershoot as it may carry more immediate policy repercussions. There will clearly be a downgrade to the 2024 HICP picture, but maybe little more than this, not least as the ECB may suggest that easier financial conditions in the wake of the (admittedly partly-reversed) fall in bond yields may lift activity in due course. This may encompass a clear debate as, at the last meeting, it was noted that market rate thinking then encompassing much clearer and earlier rate cuts) was in part an circular reaction and thus needed to be carefully assessed – in other words market rate thinking reflected a different (and possibly more valid) trajectory for both inflation and real growth.
But the hawks may point to less weak PMI data as a sign that recovery may already be emerging, even though other business survey data suggest the very opposite as do fresh signs of falls in both bank deposits and credit levels. But the hawks may also suggest that if the activity projections are pared back, this may also mean an even weaker productivity outlook which would lift unit labor costs growth even further above the 2% 2025 forecast, thereby acting as a probably break on any further disinflation. Overall, despite what it regards are less downbeat real economy signs, the ECB may still see growth risks being (justifiably) tilted to the downside. But it may again be deliberately vague as to where the balance of inflation risks lie. Despite the February HICP numbers, we think they have surprised to the downside and will continue to do, not least as we would regard that the a good portion of disinflation is supply driven and that with policy hikes still biting the impact of weak demand will only accentuated this.
Genuine Rate Cut Discussion Inevitable?
Such possible considerations are likely to mean a genuine discussion about rate cuts, albeit merely their possible extent and the likely timing of the first move as well as a clear hint that the QT program and balance sheet reduction will (at least for now) proceed regardless. This will be a change to what happened at the January Council meeting where the account regarded it as premature to discuss easing, this albeit only by consensus, implying a minority wanted such a debate at the January meeting. That minority may be larger and more vocal this time. They may even be persuasive enough to leave open the possibility of the first cut at the April meeting, albeit with the majority leaning more to the first move in summer/June and perhaps more explicitly so, possibly citing alleged evidence of economic recovery and price resilience.
This would chime with remarks aired by President Lagarde who has openly suggested rate cuts may occur in the summer, chiming with an interview from Chief Economist Lane who implied the June meeting will be critical. We still think that cuts may arrive by then, although we still pencil in no more than 75-100 bp cuts this year to be followed by a similar sized fall in 2025 starting at the June meeting.
The Last Mile Issue
Supporting this outlook, the ECB has noted the clear fall in inflation expectations, actually no longer citing such expectations as an upside risk to the inflation outlook. It also accepted that its own wage tracking pointed to a stabilization, if not an easing, in such costs pressures, this accentuated by more signs that such pressures were also being absorbed more by companies cutting profit margins. All of which came alongside clear acknowledgement that underlying inflation was falling.
As for policy tightening, the ECB is again likely to accept that past interest rate increases keep being transmitted forcefully into financing conditions, this evident in the manner in which the bank lending survey was still seeing credit standards being tightened. It was also noted that tight financing conditions are dampening demand, and this is helping to push down inflation, this possibly an implicit admission that supply factors are also contributing. And at the ECB meeting in December the ECB then noted that when looking at the annual inflation data for the last few years, it appeared that disinflation to date had actually been faster than the previous surge in inflation, questioning the empirical relevance of the “last mile” narrative that many central bankers have been highlighting.