LDN - Business

Walking a tightrope: Five questions for the ECB

[January 22, 2024] By Yoruk Bahceli and Stefano Rebaudo

(Reuters) - The European Central Bank (ECB) meets on Thursday as policymakers, not quite ready to declare victory in the inflation battle, struggle to sway trader bets on swift rate cuts.

Markets are banking on a first cut in April, but the ECB wants to see more evidence of price growth slowing before pushing the button.

"There has been so much speculation about the timing of the first rate cut," said Carsten Brzeski, global head of macro at ING. "To me the question is... whether the ECB wants to address that or not."

Here are five key questions for markets:

1/ What will happen this week?

The ECB is certain to keep rates steady, having stopped hikes in October, then clarified in December it would phase out its pandemic-era bond-buying scheme in the second half of 2024.

Analysts expect ECB chief Christine Lagarde to continue signalling it is too early to discuss rate cuts - a message not fully resonating with traders who are still pricing in 135 basis points of cuts starting in April.

Policymakers, not just hawks but even a dove such as Cyprus's Constantinos Herodotou, have pushed back. Lagarde has warned pricing in too many cuts could hurt the inflation fight. Yet they also acknowledge the need for need for "humility" given uncertainties ahead.

"Lagarde's pushback will be more indirect," said Deutsche Bank's chief European economist Mark Wall.

"She will point to the ECB's forecasts for resilient growth and inflation as a way to create some doubt that the ECB will ease quite as quickly as priced."

2/ Will the ECB pivot any time soon?

Markets reckon so. Traders have merely delayed expectations for the timing of a first cut to April from March and expect one fewer cut than they did last month.

Even hawks such as Germany's Joachim Nagel do not rule out a summer move. A shift in tone seems a matter of time.

The ECB releases new inflation and growth forecasts in March, which could set the stage for the start of a discussion on eventual easing.

3/ How far does inflation need to fall before rate cuts?

Further. Euro zone inflation rose in December for the first time since April, reaching 2.9%. While core inflation fell further, it is still above 3%.

The ECB will want headline and core inflation below 2.5% to be comfortable the 2% target is in reach before cutting rates, said Berenberg chief economist Holger Schmieding.

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The skyline, with the banking district and the European Central Bank (ECB) visible, is photographed in Frankfurt, Germany, August 13, 2019. REUTERS/Kai Pfaffenbach

Investors are more confident; swaps markets point to inflation just above 1.5% in a year.

The ECB could be pressed on the impact of Red Sea tensions, which highlight how supply chain shocks are becoming more frequent.

4/ What about wages?

The ECB has singled out wages as the biggest inflationary risk. Unemployment remains at a record low.

Pay growth is down from 5.2% in October 2022, a wage tracker by recruitment platform Indeed and Ireland's central bank shows, but ticked up to 3.8% in December.

Economists reckon that's driven by new wage deals, an effect seen continuing early this year.

The ECB will likely assess first quarter deals to see if pay growth falls towards the 3% it sees consistent with 2% inflation before signalling a policy shift.

Lagarde expects enough data by "late spring" and chief economist Philip Lane wants to see data due in April. This would rule out a rate cut before June, the most likely start date for easing, a Reuters poll shows.

"The decline in headline inflation, the fact that inflation expectations are stable, all that points to the moderation in wages... but it's not in the data yet," said Dirk Schumacher, head of European macro research at Natixis.

5/ How worrying is the euro zone economy?

For the ECB, inflation still trumps growth concerns.

With the economy seen in a shallow recession, expected to have shrunk just 0.3% in the fourth quarter, whether rate cuts start in April or in the summer won't make a real difference, economists said.

"The ECB will take the view that a rate cut wouldn't help," said ING's Brzeski. "This is why they can really focus on inflation."

(Reporting by Yoruk Bahceli in Amsterdam and Stefan Rebaudo in Milan; Graphics by Sumanta Sen, Pasit Kongkunakornkul, Riddhima Talwani and Vineet Sachdev; Editing by Dhara Ranasinghe and Alex Richardson)

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