The ECB is more hawkish than the Fed. But markets see rate cuts of 1.5% in 2024

The ECB is showing a more hawkish bias than the Fed, despite lower inflation and much lower growth in the Eurozone than in the US. Yesterday, the ECB Governing Council left rates unchanged (the DFR is at 4%) but decided to reduce Pepp's bond reinvestments by 7.5 billion per month from mid-2024, with a final halt at the end of next year.

Guard remains high on inflation

President Christine Lagarde attempted (unsuccessfully) to dismiss market expectations for a rate cut in March and pointed out that the ECB did not discuss the timing of a rate cut yesterday, unlike Fed Chairman Jerome Powell's statement the day before.

In addition, Lagarde emphasised that "the guard has not been lowered" on inflation because of concerns about wage growth and the recent decline in market rates not incorporated in the new projections published yesterday. The macro forecasts, however, although the ECB president did not mention it, did not even include the latest negative data on growth and industrial production.

Market expectations

Lagarde invited to look at the data, especially those on the labour market, which will come in the 'first half of 2024'. Thus some economists have pointed to the first cut in June. This timing, however, contrasts with market expectations: participants are betting on a first cut in March (with a 65% probability) and expect rate cuts of 150 basis points next year.

Upcoming economic data will be decisive

Lagarde did not repeat yesterday that inflation 'is too high for too long' and did not explicitly rule out cuts for two quarters, as she had done in mid-November. But overall 'the ECB's message was mixed, in contrast to the Fed's dovish turn', Bnp Paribas noted. The euro strengthened against the dollar.

In the coming months, however, the economy may force the ECB to accelerate its monetary policy pivot. In its new projections, drawn up with the national central banks, Frankfurt lowered its growth estimates for the eurozone, even though a recession is not expected, and lowered its inflation expectation for next year from 3.2 to 2.7 per cent, leaving the one for 2025 unchanged at 2.1 per cent. The inflation rate is expected to be 2% as early as the third quarter of 2025. In 2026 the price increase would fall to 1.9%, thus below the ECB target.

But Lagarde nevertheless emphasised the 2025 figure (shortening the horizon of the projections) and highlighted the upward risks on inflation (starting with wages, although no economist assumes price spirals) more firmly, admitting that the ECB is 'severe' on itself. This severity could translate into a higher-than-expected drop in inflation and growth again, with another revision of projections in March possibly heralding a subsequent rate cut, even before June according to the markets.

The Pepp reduction from mid-2024

Against this macro backdrop, no data can be found to justify the additional, albeit slight, restriction due to the anticipated reduction in the reinvestment of Pepp bonds. The ECB will reduce the balance sheet by a further 45 billion in 2024: about 8-9 should concern Italian bonds, according to market estimates. Lagarde said only that it is 'a good moment' and that 'there is no risk of fragmentation in the Eurozone', pointing out that some members would have preferred a faster exit and others a slower one. But he did not explain the economic reasons for the decision, wanted by the hawks to reduce exposure to government bonds. The Btp-Bund spread still fell yesterday. On the whole, however, the ECB maintained a hawkish stance, despite the German hawk of the board Isabel Schnabel's admission that she had misjudged inflation. A real pivot could however come after the economic data in the coming months.

• Italian version: La Bce è più falco della Fed. Ma i mercati vedono tagli dei tassi dell’1,5% nel 2024