ECB preview: Still too early to declare victory over inflation
|Next week’s ECB meeting is set to see few, if any, new policy signals, given the limited new information that has been released since the December meeting. We expect President Lagarde to confirm that the next policy rate change is most likely a cut, which may happen in summer. It remains to be seen whether the June meeting will be singled out as the key meeting to watch, similar to Lane’s comments this weekend. We expect Lagarde to repeat the three key criteria for setting the policy rates, which should point to the new staff projections in March as key.
Markets are pricing the first ECB policy rate cut for April, and a total of 135bp through to the end of 2024. The policy rates are priced to trough at 2% in two years’ time.
Still too early for ECB to declare victory over inflation
Since the latest governing council meeting mid-December, we have received one additional inflation print. Headline inflation picked up to 2.9% y/y in December from 2.4% in November driven by energy base effects, while core inflation continued to fall to 3.4% y/y from 3.6%. For Q4 23, headline inflation came in at 2.7% y/y, which was lower than the December ECB staff projections of 2.8% y/y. Similarly, core inflation came in 0.1 pp lower than the projection of 3.8% y/y in Q4. Philip Lane has downplayed the importance of this downside surprise probably because it was small and some to extent expected, as the ECB was aware of the November print at the December policy meeting, but the print came in after the cut-off date for the December staff projections. Hence, we do not think the ECB has changed its overall assessment of inflation since the last policy meeting.
In the bigger picture, the disinflation process continues as also noted in the continued easing of most underlying inflation indicators. For example, the 3m/3m seasonally adjusted annualized core inflation was significantly lower than 2% at just 1.4%. The service inflation momentum is still above 2% though, which is important given the service price momentum moving in tandem with a tight labour market (the November unemployment rate declined to an all-time low of 6.4%) and the many wage negotiations schedules for Q1 24 underscore that it is still too early to declare victory over inflation. Most recently there has been a stabilisation in the 3m average of the job portal Indeed’s wage listings. The ECB will likely share this assessment and wait for more data prints before it starts talking about easing.
Growth ended 2023 on a weak footing, and likely to stay weak near term
Growth ended the year in contractionary territory as manufacturing PMI remained at 44.4 (November: 44.2) and service PMI came in at 48.8 (November: 48.7). The weak manufacturing activity was visible in the November industrial production figures that declined 0.3% m/m and in industry-heavy Germany that saw Q4 GDP growth at -0.3% q/q. While the current growth momentum is weak, it is not collapsing and thus the ECB will not use this as an argument for easing policy as it (and we) forecasts a gradual rebound in activity through 2024. Rising real wages and a strong labour market in combination with leading indicators showing a turn in the global manufacturing cycle will support growth in 2024 so the euro area avoids a recession.
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