by Dhara Ranasinghe and Stefano Rebaudo
LONDON, March 4 – The European Central Bank (ECB) will deliver its monetary policy decision on Thursday as investors continue to question the timing of a first interest rate cut.
The Frankfurt institute, which is expected to keep the deposit rate at a record 4%, faces a delicate balancing act between dropping borrowing costs too quickly that could revive inflation and cutting them too late which would harm the economy.
“ECB stakeholders, even if they have different views on the timetable, have recognized that rate cuts are coming,” observes Jens Eisenschmidt, analyst at Morgan Stanley. “The March meeting will be an opportunity to change the wording of the communiqué to signal this.”
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1/ Can the ECB modify its communication?
The ECB has signaled that it will be patient in reducing interest rates, but an easing is still expected by markets, which are seeking indications on the timing of the first measures.
Governing Council member Peter Kazimir says the ECB should acknowledge that the inflation outlook has improved at its meeting, but it should avoid committing to cut interest rates and wait until June to take such action.
Markets now expect 90 basis points of cumulative rate cuts in 2024, compared to 150 points at the start of the year.
2/ Is there a risk that the ECB will reduce its rates too late?
For sure. A delay in rate cuts would increase the risk of more aggressive intervention in the event of a larger-than-expected decline in inflation.
According to François Villeroy de Galhau, member of the ECB Governing Council, “it is not a question of rushing; but acting with gradualism and pragmatism may be preferable to deciding too late and then having to over-adjust”.
Even Yannis Stournaras, member of the institution’s board of governors, believes that the end of the first semester could be the “optimal moment”.
“If this is the message from a Greek central banker, it is probably a good indicator that it is in June that we will see action, not earlier,” said Gareth Hill, an analyst at Royal London Asset Management .
3/ What about salaries?
The ECB has identified wages as the most important factor in determining if and when it will undertake a rate cut.
Wage growth in the euro zone slowed to 4.46% in the fourth quarter, from 4.69% in the previous quarter, the highest rate on record since 2005.
The more forward-looking Indeed Wage Index peaked at the end of 2022, but was still at 3.9% in January, above the 3% that the ECB considers consistent with inflation target of 2%.
First quarter wage data, crucial for the ECB, will not be published until May.
4/ What will the latest ECB forecasts reveal?
Economists expect downward revisions to growth and inflation forecasts for 2024.
Eurozone growth has hovered around zero for six consecutive quarters and the European Commission forecasts that GDP in the 20 countries sharing the euro will increase by just 0.8% in 2024, down from 1.2% expected in November .
Preliminary data published by Eurostat on Friday showed a slowdown in inflation, with the consumer price index calculated according to European standards (HICP) increasing by 2.6% in February, compared to 2.8% the previous month.
“The ECB’s forecasts for headline inflation should be revised downwards because energy prices are around 20% lower than at the time of the December macroeconomic projections,” underlines Andrzej Szczepaniak, analyst at Nomura.
5/ Can the ECB reduce its rates before the Federal Reserve?
Yes, although this has rarely been the case in the past. The euro zone’s economy is weaker than that of the United States, meaning the case for monetary easing in the bloc is stronger than across the Atlantic.
According to LSEG data, traders believe there is a high chance that the ECB and the Federal Reserve (Fed) will start cutting rates in June, with a slightly higher probability for the ECB.
“I don’t think there is a strong economic argument to say that the ECB cannot act before the Fed does,” said Rohan Khanna, analyst at Barclays.
However, the ECB has always historically initiated its measures after the Fed. And a rate cut before the US central bank would put the euro under pressure.
(Reporting by Dhara Ranasinghe in London and Stefano Rebaudo in Milan; with the contribution of Yoruk Bahceli; French version Augustin Turpin, edited by Blandine Hénault)
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