This article is only available to Macro Hive subscribers. Sign-up to receive world-class macro analysis with a daily curated newsletter, podcast, original content from award-winning researchers, cross market strategy, equity insights, trade ideas, crypto flow frameworks, academic paper summaries, explanation and analysis of market-moving events, community investor chat room, and more.
Summary
- Since our ECB monitor last month, wage data shows further slowing in Q2. This will ease ECB concerns about the risk of an overshoot given the staggered nature of the negotiated wage agreements.
- While Q2 GDP data was revised lower, excluding Ireland, EZ growth remains fine. Finally, inflation continued to cool in August but remains above the ECB’s forecasts suggesting slower disinflation than envisaged.
- Schnabel, in her most recent speech on 30 August, made her case once again for a gradual and cautious dialling back of policy restraint.
Market Implications
- We think the ECB will cut 25bps on Thursday.
- A further cut in October is possible but needs supporting data in the form of a sharper slowdown or weaker inflation. December remains our base case for the second cut.
- We also expect downward revisions to the ECB’s GDP 2024 growth forecast, while the forecast for core could be revised marginally higher.
September Cut Confirmed, Sticky Inflation May Keep Cutting Slow
Last month, we argued the ECB would likely cut 25bp in September but that slow disinflation made the decision uncertain.
Since then, the incoming data has leaned marginally dovish, which should cement the 25bp cut priced by the market. Moreover, we pay particular attention to the ECB’s updated forecasts, as both growth and inflation estimates could be revised.
Q2 GDP Revisions Negative, but ex-Ireland Growth Still Above ECB Forecast
Q2’s revised growth data (to 0.2% QoQ from 0.3%) paints a slightly bleaker picture for the EZ economy. Growth composition deteriorated too, with household consumption declining 0.1% QoQ from 0.3%, while fixed capital investment fell by 2.2% QoQ.
As always, Ireland’s national accounts played a role, driving the downward revision to fixed capital investment. Absent Ireland’s impact, the Eurozone economy grew 0.25% QoQ or 0.8% YoY, above the ECB’s Q2 forecast of 0.6% YoY.
Q3 and Q4 growth forecasts may also see downward revisions. However, we do not see broader large revisions to 2025 GDP growth given the trajectory of real income growth.
Wage Growth Slows Further, Reducing Upside Risks to Inflation
There were two dovish surprises on the wage front.
First, negotiated wage growth slowed sharply to 3.6% YoY from 4.7% YoY last quarter. The ECB will welcome this outturn having looked through the Q1 data on the back of one-offs.
Second, compensation per employee slowed further to 4.3% YoY from 4.7% YoY in Q1. With this outturn, compensation per employee falls far below the Q2 and Q3 forecast of 5.1% YoY and 4.7% YoY respectively.
While the wage data can be volatile, the ECB will view the Q2 slowdown positively. This is because it wants tight monetary policy to restrict the relationship between higher prices and wages, which looks to be happening.
Preliminary CPI Shows Further Progress in Core, But Disinflation Still Slow
August’s preliminary core inflation outturn showed further cooling to 2.8% YoY from 2.9% last month. Yet it remains above the ECB’s June forecast. We think this will prevent the ECB from becoming more dovish, keeping their current ‘meeting by meeting’ approach in place.
The preliminary print may prompt an upward revision to 2024’s inflation forecast by 0.1%. However, we do not anticipate similar hawkish revisions to 2025. One reason is more favourable wage data. Another is that the price component within the ECB surveys shows continued disinflation, including in the services sector closely watched by the ECB.
Employment Growth Still Robust, Unemployment Rate Declines
Finally, the EZ economy continues to add jobs at a robust pace with QoQ employment rising by 0.2% QoQ in Q2, above the ECB forecast of just 0.1%. Moreover, the unemployment rate continues to decline (to 6.4% in July from 6.5% per the latest ECB forecast), contrasting other major economies.
Strong employment growth delays the need for the ECB to frontload cuts. Meanwhile, a declining unemployment rate does little to ease ongoing labour shortages within the services sector.
In sum, the ECB will take comfort from the recent wage data, but sticky inflation and a robust labour market will do little to accelerate the cutting cycle. Finally, given the ECB was largely willing to look beyond more hawkish Q1 outturns, they may also look beyond some of the promising Q2 data.
Schnabel Leans Towards Gradual Cutting Cycle
The main ECB speaker over the past two weeks was Schnabel on 30 August. Despite acknowledging increased growth risks, a soft landing remains her base case. Schnabel also welcomed the fact that firms have begun to use their profit margins to absorb cost increases rather than pass these to the consumer. This means that the contribution of unit profit growth to inflation has reduced over the past 12 months.
Finally, she highlighted three possible scenarios ahead:
- Base case: inflation continues to slow and falls sustainably back to the ECB’s target by the end of 2025. This will be driven by slowing wage growth, easing price pressures outside of the services sector, and tight monetary policy helping to constrain aggregate demand (as shown by rising savings intentions).
- Higher wage scenario: Sticky wage growth remains the ECB’s main concern. Two key factors could keep it elevated: 1) the staggered nature of negotiated wage agreements, and 2) weak productivity growth.
- Geopolitical risks and protectionism: Another scenario that could keep inflation above the ECB’s target is further risks stemming from geopolitical tensions such as increased shipping costs or a commodity shock. Finally, Schnabel highlighted the risk of rising protectionism, which could be a nod to a potential Trump presidency.
These scenarios suggest Schnabel sees a heightened risk of upside surprises in inflation rather than downside. This supports her view that cuts should be ‘gradual’ and ‘cautious’. We expect Lagarde to lean in a similar direction.
(The commentary contained in the above article does not constitute an offer or a solicitation, or a recommendation to implement or liquidate an investment or to carry out any other transaction. It should not be used as a basis for any investment decision or other decision. Any investment decision should be based on appropriate professional advice specific to your needs.)