Will they or won’t they? Ahead of the ECB meeting on Thursday 18th July, investment experts and economists have been sharing their expectations with IFA Magazine as to whether we might see a further cut to interest rates in the EU this week.
Spoiler alert…expectations are that any change to EU interest rates is highly unlikely. Why? See the rationale from our experts below:
Shaan Raithatha, senior economist at Vanguard Europe, believes that the ECB will keep policy on hold on Thursday, after initiating its rate-easing cycle last month saying:
“The European Central Bank (ECB) is widely expected to remain on hold on Thursday and this meeting is unlikely to bring in major news. That said, there will be updated language on how the outlook for activity and inflation has evolved since June. Our judgement is that, if anything, a September cut is slightly more likely than six weeks ago. Although inflation moved sideways in annual terms in June, largely due to elevated services inflation, growth momentum disappointed (e.g., see German industrial production and euro area services PMI) and soft U.S. inflation prints now make it more likely the Fed will cut in September.
“Ultimately, the pace of easing will depend on the expected trajectory for services inflation, which the ECB believes is primarily driven by wage growth. Compensation per employee grew 5.1% on an annual basis in Q1, which was broadly in line with the ECB’s June forecast. President Lagarde, in Sintra, attributed most of this strength to catch-up effects and one-off payments in Germany, and expects a significant moderation in the coming quarters, in line with survey evidence. That said, monthly wage surveys have been mixed in the last six weeks, with the Indeed wage tracker reaccelerating but German monthly negotiated wage growth slowing in Q2. Surveys still signal underlying wage growth to slow to under 4% by year-end, which would pave the way for the 2% inflation target to be hit in H1 25.
“There are three key pieces of data to watch out for between now and September. The first two are the July and August flash CPI prints. Although key Governing Council members such as Vice President Luis de Guindos have stated inflation will be bumpy in the near-term and this will not deter the ECB from cutting, significant upside surprises to this data, particularly on the services front, could be sufficient to warrant policy remaining on hold until Q4. The third piece of data is the Q2 release on wages, productivity, and corporate profits, which will reveal whether the ECB’s forecasts for unit labour costs are still on track. This is a key piece of evidence for the outlook for services inflation.
“In our view, the ECB will back-up its 25-basis point June cut with another one in September and continue to ease on a quarterly basis thereafter. Top of mind is that, by doing nothing, monetary policy becomes increasingly restrictive in real terms as progress on inflation continues. We still expect underwhelming growth this year (0.8%) amid the dual headwinds of contractionary monetary and fiscal policy, coupled with the lingering effects of the energy crisis on manufacturing industries. Expect core inflation to end the year at 2.6% and hit the 2% target in Q2 25.”
Also commenting, 18 July, Peter Goves, Head of Developed Market Debt Sovereign Research at MFS Investment Management said:
“We expect no change in ECB policy rates when the Governing Council meets this week. Since its last meeting, the central bank has continued to stress the data dependency approach. The June updated projections showed a small upward revision in the inflation forecast for both 2024 and 2025 (now at 2.5% and 2.2% from 2.3% and 2%) and Lagarde has stressed the need to analyze a whole range of data to achieve more clarity on the inflation outlook. Residual inflation stickiness in services, wage data and ECB rhetoric means a hold is more likely than not this week. Overall, we still see growth as generally below potential and look for wage data and domestic inflation to fall. We continue to pencil two more 25bp cuts this year.
“Our view remains that the modest growth outlook and falling inflation will mean cuts remain on the table. We expect upcoming inflation data and new projections in September to validate a cut at that meeting. Rates will still remain restrictive at 3.50% by September, with more scope to cut towards neutral in late 2024 and 2025. Risks around more stickiness in services inflation could move the needle towards an even more cautious approach by some Governing Council members.
“Given the mixed data and ECB rhetoric, it is entirely understandable that the market places a near zero chance of any move in policy this week. September isn’t fully priced which leaves some further scope for a rally on a 25bp cut delivered at that meeting. This keeps us constructive on euro area duration over the near and medium term. EGB spreads remain relatively contained given the French event risk (that proved relatively short lived and more idiosyncractic than systemic). We see this as a potential item to come up in the press conference, but we doubt Lagarde will veer into opinions on the domestic French political situation. Furthermore, Lagarde will likely affirm that transmission of monetary policy has worked well.“
Another analyst is in agreement that we’re unlikely to see a cut this week, as Daniela Sabin Hathorn, senior market analyst at Capital.com said: “Data from Reuters shows markets expect no change to policy, with a 95% chance priced in. The fact that we got a rate cut from the ECB in June pushed back expectations of another cut to September, especially as President Christine Lagarde hinted at taking it slow. Current pricing shows an 80% chance of a September cut.
“The central bank made it very clear at its previous meeting that it does not want to follow a fixed schedule for determining when and how much to cut, but would rather be reactive to the data. Lagarde and her team will likely continue to avoid giving explicit guidance, and the messaging could remain mostly unchanged from June.
“The latest data showed inflation dropping marginally in June after rising unexpectedly in May although that didn’t stop the central bank from cutting rates 25 basis points back then. Whilst the disinflation process has come a long way in the past 18 months, price pressures remain sticky in some areas of the economy, limiting the ECB from starting a strict cutting cycle.
“From Lagarde’s comments back in June, the bank would rather take on a ‘wait and see’ approach as it enables the transmission of policy into the economy to take place, observing how rate cuts affect the economy before lowering rates further. Meanwhile, the labour market has remained strong, which allows the ECB to gather data without being forced to act to save the economy.
“After the hype of the June meeting, this Thursday is expected to be a bit of a non-eventer. With the start of the summer, it is unlikely that the central bank wants to unsettle markets. It also helps that most of the Governing Council members seem to be happy with the current market expectation of two more rate cuts this year. The fact that this cutting cycle has not been triggered by a recession or crisis gives the ECB ample room to manoeuvre comfortably, which means we could see a few meetings this year when nothing much happens.
“Because of this, the momentum in markets could be subdued following the meeting. EUR/USD has been on a strong bullish run in recent weeks, also helped by a weaker dollar, but the momentum has started to fade just above the 1.09 mark, with the RSI flattening out. A hold from the ECB could see some mild downside pressure on the euro as markets rebalance the recent moves. Meanwhile, European equity indices like the DAX 40 and EURO STOXX 50 have pulled back from recent highs. Commentary from Lagarde will be key to determining further appetite to push higher. A dovish tone which implies a rate cut in September could reignite some buying interest.”