ECB majority eyes neutral policy stance, diverging from market expectations

Markets

The ECB yesterday stuck with its 25 bps easing pace, even though a larger step (50 bps) was briefly discussed. Updated inflation forecasts back the gradual approach. They were marginally revised down to 2.4% and 2.1% for this year and next while the 2026 projection was left unchanged at 1.9% and the first estimate for 2027 came in at 2.1%. Core inflation for 2025 is seen at 2.3% (unchanged) and at 1.9% for both 2026 (-0.1 ppt) and 2027. This near 2% projection path probably kept the central bank from switching to forward-looking decision backing instead sticking with the data-dependent approach. The latter probably serves the ECB best during Q1 2025 when EMU growth figures are unlikely to rebound given the amount of (geo)political and economic uncertainty. On inflation, Lagarde already hedged herself. After a final (base-effect) increase in December, CPI should be on a bumpy path back to 2%. The timing of the March meeting (March 06) also means a rather limited availability of fresh data to prompt big policy changes. That’s why we eye back-to-back 25 bps rate cuts at the Q1 2025 ECB policy meetings, bringing the deposit rate to 2.5%. And that’s when it becomes interesting. The ECB yesterday dropped the reference to targeting a restrictive monetary policy, implying that the hunt to “neutral” is one. At the press conference, Lagarde said that the neutral level wasn’t debated, but she admitted that it was probably a little higher than before. We believe that the majority inside the ECB is aiming a return to neutral (+-2.25%?) and not to stimulative monetary policy like money markets are still discounting. The equation could change if downside risks surrounding the lowered growth outlook (0.7%-1.1%-1.4%-1.3%) materialize. By sticking to the neutral story and not opening the door to larger rate cuts, Lagarde triggered a correction higher in EUR rates. Daily changes on the German yield curve varied between +6.8 bps and +8.2 bps, with the belly of the curve underperforming the wings. We stress the continuing bottoming out process at the (very) long end of the curve. The US yield curve bear steepened, with yields adding 3.8 bps (2-yr) to 6.2 bps (30-yr) with tepid demand for the 30-yr Bond sale. EUR/USD tried, but failed, to regain the 1.05 handle, closing at 1.0464. Today’s empty eco calendar gives way to further digesting yesterday’s news/market moves.

News and views

Japan’s Q4 Tankan survey showed marginal improvement in the manufacturing sector’s index from 13 to 14 in a sign of corporate resilience amidst slow Chinese growth and the US tariff threat. Subsectors as petroleum & coal products (+26 points from Q3) and machinery production (+8) printed some of the biggest changes. The outlook (13) withstood overall uncertainty slightly better than expected (13 s 12 from 14). The services gauge eased to 33. The lower print in Q4 compared to Q3 was driven by a drop in retail confidence (-15 points) and in accommodations, eating & drinking services (-12). The headline index remains near the multi-decade highs of 34 though and the outlook stabilized at Q3’s 28 – the best level since 1991. The price gauges show that firms continue to expect inflation to stay above the Bank of Japan’s 2% target. Year-on-year CPI in five years’ time is seen at 2.2%, the same as in Q3. The BoJ considers this one of the key measures for gauging long-term inflation expectations. As such they continue to make a case for further policy normalization by the central bank. While there’s something to be said for a hike next week, it’s not market’s base case. The recent string of comments (eg. in Reuters’ exclusive yesterday) suggest officials are leaning toward keeping rates steady at 0.25%. USD/JPY trades around 153.

Canada is investigating the use of export taxes on important commodity products including uranium, potash and crude, it is sending to the US, Bloomberg reported citing sources yesterday. The move comes after president-elect Trump two weeks ago threatened to slap Canadian imports with a 25% tariff. Canadian observers believe Trump is only eying manufacturing industries and would exempt the above-mentioned commodities in order to keep critical supply flowing. Canada is the largest external supplier of oil to the US (especially Midwest) as well as the biggest foreign supplier of uranium fuel for the US’ nuclear power plants while the potash it exports is a huge source of fertilizer for American farms. The officials said the export levies would only be as a last resort with Canadian retaliatory tariffs on US imports and export controls on certain products to be more likely to come first. The Canadian dollar yesterday weakened to north of USD/CAD 1.42 for the first time in the post-pandemic period.

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