Flash: ECB preview – No new signals

When the ECB meets next week, the policy decision is essentially already guided, namely another 25bp cut which brings the policy rate to 2.75%. This is a unanimous expectation among analysts and markets. With the near-term uncertainties prevailing from the Trump administration as well as continuing domestic economic resilience we do not expect new signals on the policy rate outlook. Thus we 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.

Markets are pricing virtually another 100bp worth of rate cuts this year. While we expect the ECB to cut more than this, we see the risk of a December repeat of an initial hawkish market reaction due to Lagarde not committing to the end point of this cutting cycle may play out again.

Markets price 100bp worth of rate cuts this year

The ECB’s framework in recent quarters, focusing on data dependency and not data point dependency using its three-tiered reaction function, has led markets to trade its own narrative, as the ECB has chosen not to signal the policy outlook beyond the very near term. While it does not want to be data-point dependent, we find it difficult for the ECB not to weigh timely incoming data due to the elevated uncertainty surrounding the labour market and growth outlook. We saw it most recently in the fall last year where the weakness in European data in September / October made the ECB change the otherwise “hold guidance” to “cut guidance”, and ultimately deliver a rate cut.

Under-appreciated risk as policy level approaches neutral

During the press conference following the December meeting, Lagarde said that they didn't discuss the neutral rate level, which means they did not discuss the end point of this cutting cycle. She did, however, say that the discussion would take place once they come closer to that neutral rate level. During that occasion she repeatedly referenced the study from earlier 2024 that pointed to a range of neutral real rates between -0.5% and 0%. Lagarde also said that the conventional wisdom suggests that the neutral rate is probably a little higher than before. Assuming a 2% inflation target, that means that they would only be at neutral in June this year, if they cut 25bp at each of the four upcoming meetings. This consecutive rate cutting cycle seems to be getting a wide backing, particularly by the doves for the coming 3-4 cuts of 25bp. Villeroy, Kazimir alluded to this while Vujcic said that he is not uncomfortable with the current market pricing. Knot said he is comfortable with the market pricing for the coming two meetings but needs to see further data for decisions after that. He is not convinced that they need to go into stimulative territory. While it’s tangible for financial markets to discuss a yield level of where the cutting cycle ends, we find the key discussion to be had is what kind of policy stance is ultimately needed? We have only had limited guidance from GC members on this, with either guidance of a neutral stance or guidance of not being convinced to go into stimulative mode, however we expect this discussion to intensify in the GC after the March meeting.

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