ECB Preview: Expect a 25bp Cut – Focus on September

Summary

• We expect the ECB will cut 25bp on Thursday, but more interesting will be their forecasts and subsequent actions.
• We expect little change to the forecasts, with the ECB looking through recent labour market strength but providing a modestly higher profile for medium-term inflation.
• Services and domestic inflation will remain key, particularly if goods disinflation slows.
• We expect no strong forward guidance. Lagarde will probably argue for proceeding cautiously but lean towards September for the next cut.
• She will likely keep emphasising the ECB can deviate from the Fed.

Market Implications

• We expect three cuts in 2024 versus market pricing of c.2.5 cuts.
• Watch for opportunities in EUR swap steepeners, which remain inverted in the short end. A credible policy divergence from the Fed could provide impetus for re-steepening.

ECB to Cut 25bp, Focus to Shift to September

We expect the ECB will cut rates 25bp on Thursday. A first cut in June has been our base case since last December. But what next? Consensus is growing for a September cut at the earliest. We expect Lagarde will caveat the recent strong wage and inflation data, reaffirm the ECB’s data-dependent, per-meeting approach, but also build the case for potentially more easing ahead.

Strong forward guidance is unlikely. Lagarde will probably argue for proceeding cautiously but lean towards September for the next cut and strongly reject dependence on the Fed.

We watch for opportunities in EUR swap steepeners, which remain inverted in the short end. Our PCA model is already flagging steepeners across EGB curves. If the tone out of the ECB is more dovish, we could see re-steepening.

Forecasts May Support Medium-Term CPI

Updated forecasts will provide clues on policymakers’ thoughts. There, headline and core appear little different from their expectations from March (Charts 1 and 2). Near-term headline inflation could see a slight downward revision, but medium-term inflation is more likely to be revised upwards due to a stronger labour market and more persistent core inflation.

The ECB focuses heavily on domestic inflation, which remains elevated. However, as Lane noted in his last speech, its breadth is narrowing.

The recent momentum in services inflation is more concerning – with a good chunk driven by rising wage-intensive services inflation (Chart 3). This bounce in recent momentum has occurred across many of the EZ countries (Chart 4).

As Lane noted, they will need a fall in wage inflation to keep labour-intensive sector inflation down.

On the labour market, unemployment still undershoots ECB expectations, and Q1 negotiated wage growth surprised to the upside (Charts 5). The ECB has tended to look through previous undershoots in unemployment; they may continue to do so.

On wages, while the outturn for Q1 negotiated wages was concerning, the broader picture still indicates slowing momentum (Chart 6). Recent momentum does not look at odds with the ECB’s March forecast of +4.5% employee compensation growth for the year. They will likely continue to expect wage growth to drop into summer before rising into yearend.

Lagarde will probably echo Lane’s comments in dismissing much of the rise in Q1 negotiated wage growth as ‘one-off payments’, while noting productivity growth will sap some of the inflationary impact.

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Henry Occleston is a strategist who focuses on European markets. Formerly, he worked in European credit and rates strategy at Mizuho Bank, and market strategy at Lloyds Bank.

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(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.)