A cut is the easy part

The ECB meeting next week is expected to end with yet another 25bp rate cut, bringing the policy rate to 2.5%, 150bp lower than the peak last year. While the cut decision is relatively straightforward, divergences in the ECB GC members’ assessment of the policy stance is starting to show, thus a key question will be whether the ECB will start now to soften its assessment on monetary policy restrictiveness.

We continue to expect the three-tiered reaction function to prevail (inflation outlook, underlying inflation and strength of monetary policy transmission) and the data dependency to be reiterated. We expect the new staff projections to show higher inflation this year (2.3% y/y, December projection: 2.1% y/y) due to higher energy prices, while core inflation, more importantly, is likely to be revised down to 2.2% y/y for 2025 from its 2.3% level in December. We expect no changes to the growth forecast except a small downward revision to 1.0% y/y for 2025 due to a lower growth overhang from 2024.

Markets are pricing another 59bp worth of rate cuts this year, following next week’s 25bp rate cut. We expect ECB to cut more than this to end with a terminal rate of 1.5% in H2 this year, albeit risks are slightly skewed to the upside.

Diverging views

The ECB GC members have started to position themselves more vocally ahead of the upcoming ECB meetings, and at least two camps have emerged. These differences do not seem significant enough to affect the policy decision of a rate cut that we and markets expect in March, but there appears to be a significant difference of opinion on the risks emerging as the easing cycle is maturing. The views may converge once more data comes in, but with the difference in views, we can expect front-end volatility to be higher than it would be otherwise.

We identify the hawkish camp, with comments from Schnabel and Wunsch, against the dovish camp, with comments from Panetta and Stournaras. The difference of views emerges from the degree of restrictiveness that we currently have. Last week, Schnabel said that she is ‘no longer sure whether it is still restrictive’, while the dovish camp was of the view from the ECB assessed in January that ‘financing conditions continue to be tight, also because monetary policy remains restrictive’. To nuance this discussion, one first has to agree on what levels of interest rate are actually restrictive, neutral and accommodative, and here we also expect to see a diverging set of views, which we discussed in our previous ECB preview ahead of the January meeting. In the end, we expect the ECB to guide that the past policy rate cuts are starting to transmit to the economy and it is warranted to assess the required level of monetary policy restrictiveness on an ongoing basis, thus using a more vague language on the exact restrictiveness level. We believe this is a compromise that both the doves and the hawks can subscribe to.

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