The ECB will stand firm on rates at its July 18 meeting. Lagarde will not pre-commit on September because of uncertainty. Here's what to expect

The ECB will leave rates unchanged at Thursday's meeting. President Christine Lagarde is not expected to unravel on future moves, keeping the "data-dependent" approach, although after the first cut in June, markets expect (with 85 percent probability) a new cut on Sept. 12, six days before a possible similar move by the Fed.

Traders looking for clues are expected to be disappointed on Thursday. Lagarde showed no haste at the annual Sintra forum, pointing out that labor market resilience allows time to build confidence about inflation returning to 2 percent. In addition, some board members, regretting the early go-ahead for the June cut, would like to avoid the same scenario for September, preferring to leave all options open.

Decisions thus will remain "meeting by meeting," amid an uncertain political environment in France and the U.S. after the attack on Donald Trump. After the French elections, the ECB put aside emergency intervention on government bonds through the Tpi (Transmission Protection Instrument) shield. However, some governors fear a slowdown in deficit reduction in France, such that inflation will be pushed up.

The risks to the economy

The data actually rather raise fears of a new economic slowdown and inflation below the 2 percent target. Eurozone GDP rose 0.3 percent in the first quarter after five quarters of stagnation, raising hopes for a sharper recovery later in the year. However, this prospect seems less likely after the latest data.

Industrial production in the eurozone fell 0.6 percent in May compared to April and 2.9 percent year-on-year, according to data released yesterday by Eurostat. "The outlook remains weak, although the decline is less than the expected 1 percent," Capital Economics noted. "Excluding Ireland, whose data are notoriously volatile, Eurozone industrial production fell 1.3 percent month-on-month and was 4.3 percent below May 2023."

Industrial production increased in May in Italy (+0.5 percent, -3.3 percent annual), while it declined in Germany (-2.5 percent monthly in May, -6.7 percent annual) and France (-2.1 percent monthly, -3.1 percent annual). "Industrial production has been extremely weak in Italy and Germany since the beginning of 2023, while it has held up much better in France and Spain," Capital Economics noted.

As a result, the economy's recovery is linked to services, while according to economists, "the manufacturing sector will continue to struggle. The EU Commission measure of new industrial orders was extremely weak in June, and the Pmi index of new manufacturing orders remains in contractionary territory." China's slowdown will be an additional negative factor.

Weakness in manufacturing could weigh on employment sooner or later. Businesses have preferred to retain workers after the pandemic, but could cut jobs in the fall if demand remains weak.

For these reasons, too, the impact on inflation of rising wages is not a concern. Moreover, firms are reducing profit margins, thus offsetting the price effect associated with wage growth.

Some central bankers worry about the cost of living in services (+4.1 percent in June), but in this area, as Bank of Italy Governor Fabio Panetta noted, the data lags and is historically higher than overall inflation (+2.5 percent in June).

For Citi, the ECB decision to leave rates unchanged at 3.75 percent on Thursday would be "a choice, not a necessity" and would "largely reflect an asymmetric aversion to inflation above 2 percent versus below the threshold."