ECB preview: An intention to cut

An intention to cut

• We expect the key takeaway from next week's ECB meeting will be an affirmation of the prevailing ECB narrative, of the ECB on route to deliver a rate cut in June. While this meeting may be considered an interim meeting, and lead to limited market reaction, we expect the ECB to deliver a clear commitment to a June rate cut, in the form of explicit guidance of an 'intention to cut by 25bp in June'. We expect no guidance will be offered beyond that point on the pace of cuts or the end level of the tightening cycle.

• Markets are pricing 1bp for next week's meeting and 23bp of cuts in June. Our baseline scenario of three cuts of 25bp this year still holds, but see the risks skewed for ECB to deliver less than that this year, due to the sticky underlying inflation. 

Burden of proof is ‘away from June’

ECB president Lagarde’s strong speech at the ECB watchers conference two weeks ago pointed to the June meeting as the pivotal one for the ECB to start dialling back its restrictive monetary policy, as in particular she said that they 'will know a bit more by April and a lot more by June'. This narrative has seen wide support from the other GC members in recent weeks. While we do not think the specific date of the meeting when the ECB will deliver its first rate cut to be particularly important to the real economy, the consensus among virtually all GC members that a rate cut is nearby has led to market pricing being firm in calling for a rate cut in June, and a further dialling back of the restrictive monetary policy beyond June; hence, we expect firm guidance for June should not lead to a significant market impact next week. While the timing of the first rate cut being less important may even mean that the ECB could cut rates next week, the roadmap laid out by Lagarde entails a preference to wait for further information on wage growth in particular before starting to ease the current restrictive monetary policy stance. 

ECB’s roadmap laid out at the watchers’ conference

During the March meeting, and repeated in the strong ECB watchers’ speech, Lagarde set out the framework of the three criteria (inflation outlook, underlying inflation and strength of transmission) through the three phases of monetary policy: the tightening phase, the holding phase, and the dialling-back phase that the ECB is navigating.

During the watchers’ speech, Lagarde further laid out that we are exiting the second phase now and therefore about to enter the dialling-back phase, though the ECB needs to be confident that inflation is on track towards the target before that can happen. While she said that with the delays by which data becomes available, they can't wait to have all the relevant information, as this could entail a risk of adjusting policy too late, she nevertheless added that the ECB's forward-looking wage tracker 'is showing early signs that pressure is easing' and guided on wages that the negotiated wage data for Q1 would only be available by the end of May (23 May). Also, the June staff projections will show whether the inflation path, which is consistent with the 2% inflation target being reached by 2025, remains valid. If those prints are sufficiently met, a June cut would follow or, in the words of Lagarde, then 'we will be able to move into the dialling-back phase of our policy cycle and make policy less restrictive'. In other words, following the inflation data from March released this week which was in line with the ECB’s March projections, and subject to confirmation from the wage growth to be released next month, as well as new staff projections in June, the ECB would deliver a rate cut in June. Specifically, we expect the ECB to include a sentence along the lines of ‘an intention to cut rates in June by 25bp, provided that the disinflationary process continues’. This would also end discussions about a potential 50bp rate cut, as some market participants are speculating. 

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