ECB ready for rate cut in June. Lagarde fears inflation but there are risks for Eurozone growth
ECB President Christine Lagarde: we are more confident about inflation returning to 2%, but we need more data. The ECB lowers expectations on GDP and inflation. The central bank remains focused on the threat of rising inflation but there are downside risks to growth. New operating framework to be launched on 13 March
The ECB is moving towards a rate cut in June, but still risks on growth due to an approach that mainly looks at upside risks on inflation. President Christine Lagarde said at the end of the Governing Council, which left rates unchanged, that disinflation is progressing but more data will be needed: 'We are more confident about inflation returning to 2%, but not yet enough'.
Lagarde's words
Lagarde also pointed out that the decisive data, particularly on wages, will come "in the coming months. We will know more in April and much more in June'. Barring any surprises, it is therefore presumable that the cut will be mid-year. The ECB president said that yesterday in the council the discussion on the tightening reduction "just began".
Lagarde thus confirmed market expectations, which according to the president "seem to be converging" on the ECB line. Yesterday Piazza Affari rose 0.16% and government bond rates fell slightly. The new macro projections, published yesterday, once again corrected the GDP and inflation forecasts downwards. For some time now, Frankfurt has been overestimating the resilience of the economy and underestimating the decline in inflation.
ECB projections
Now the ECB forecasts inflation to return to 2% in 2025 (and 1.9% in 2026), with the core figure excluding energy and food slightly higher (at 2.1% next year, 2% in 2026). "A forward-looking central bank that plans to bring inflation back to target in 2025 should cut rates now," noted Frederik Ducrozet, head of research at Pictet Wealth Management.
Why then wait until June? According to Lagarde, there is one missing piece: the easing of domestic inflation pressures, which is mainly driven by services and wages. The ECB's caution is in all likelihood also linked to February's inflation, down but slightly above expectations (2.6% overall and 3.1% core, with some resistance from services).
Economists' comments
Wages, however, are rising due to the recovery of workers' purchasing power after years of inflation: we see no risk of wage-price spirals. Moreover, wages are only one component of final prices, which are squeezed by low demand that limits corporate profits. Medium-term inflation expectations are anchored at 2%. In any case, Frankfurt wants to be as cautious as possible on wages and services.
This cautiousness, according to Citi, leads the ECB to focus on indicators that look to the past rather than the future. Moreover, the central bank shows an asymmetrical orientation as it seems to be more accepting of inflation below 2 per cent (rather than above), going against the target.
The ECB could cut rates with similar timing as the Fed (which is expected to move in June or July), despite a much worse economic outlook. The US gdp grew by 3.1% in 2023, the Eurozone's gdp remained basically flat. One of the two central banks could thus get the timing wrong.
The weakness of the economy
The start of ECB cuts in June instead of April would not change the macro scenario, but the focus on higher inflation could be a drag on Eurozone growth. The latest data on German industry orders (-11% in January) confirmed the very weak picture of the economy.
Some analysts still considered the new ECB projections for Eurozone growth to be optimistic. Frankfurt lowered its estimate for this year from +0.8 to +0.6%, while +1.5% was confirmed for 2025. The central bank also acknowledged the 'downside risks' to growth projections.
Meanwhile, the ECB is ready to define its new operating framework, which should be based on banks' demand for liquidity. Lagarde said she expects the work to be completed on 13 March. Frankfurt yesterday also published a text to speed up the launch of the Capital Markets Union.
