By Stefan Koopman, Senior Macro Strategist at Rabobank
Prune In June?
The ECB sharpened its shears for a potential prune in June, even as it kept policy rates steady at yesterday’s meeting, aligning with expectations. Crucially, the central bank’s staff projections for both growth and inflation were revised down, with the ECB’s economists now seeing core inflation at target in 2026, and close to in 2025. This added a dovish element to the meeting, even as president Lagarde was slightly more reserved during the press conference. Nonetheless, her phrase, “we will know a little more in April, but a lot more in June,” was a signal even the famously direct Dutch could pick up on, pointing to a probable rate cut in June. This has now become our base case scenario. We expect further cuts in September and December.
The potential snag in this planned pruning could come from disappointing wage or inflation data. However, using the shears too soon raises the risk that the ECB might have to pause or reverse its course sooner than anticipated. For example, geopolitical tensions could inflate energy prices and freight rates, further jolting global trade. Moreover, with the possibility of President Trump’s return to the White House in 2025, his trade policies could impact European inflation, particularly if they speed up de-globalization and/or China decoupling. Given this backdrop, even if the easing cycle is not interrupted by a new inflationary surge, we believe that the endpoint of this cycle may be higher than markets currently anticipate. For more details, please read the ECB post-meeting comment by Bas van Geffen.
The ECB’s post-meeting cacophony is in full swing this morning. Bundesbank president Nagel said the probability is increasing we could see a rate cut before the summer break, so that could mean June or July. His French colleague Villeroy believes a rate cut in the spring is ‘very likely’, so that could mean April or June. And the Latvian central bank chief Kazaks said that the ECB should keep some optionality even after the first cut is implemented, so that means if there is a cut in June, the ECB may keep its powder dry in July. The odds of a rate cut for April are now just 17% compared to a full rate cut priced in for June. Markets anticipate nearly a full percentage point of cuts by year-end, 8 basis points more than yesterday.
The euro nonetheless climbed against the dollar, reaching 1.095 and heading for its best week of the year. This followed comments from Fed Chair Powell, who said on Thursday that the FOMC is “not far” from having the confidence that inflation would reach 2%. His colleague Mester added that a couple more inflation reports could give confidence on inflation, with the Fed likely in a position to cut rates later this year. We expect the Fed to start pruning in June. President Biden would welcome this news, as he highlighted his administration’s economic achievements in his State of the Union. Many voters still disapprove of how his administration handles the economy, even though it delivered strong job gains, low unemployment, faster-than-expected GDP growth and cooling inflation. The price level, not just its rate of change, remains a liability for the president. Unfortunately for Biden, from this point it is hard to imagine even stronger economic data. This implies that from here the risk is mostly to the downside.
The Bank of England’s DMP survey showed that UK CFOs expect lower inflation going forward, seeing their selling prices rising by 4.3% this year, while realized increases are at 5.4%. The extent of embedded selling price inflation in the UK remains an issue. Companies often adjust prices in response to expected changes in the market and to past price rises. This staggered process can keep inflation going as companies and consumers adjust to each other’s expectations. The average between expected and actual price rises suggest embedded inflation is around 4.9%, close to the survey’s measure of expected wage growth of 5.2%. So even with consumer prices possibly dropping below 2% due to lower energy costs this Spring, we think it is likely the Bank of England will lag the ECB or the Fed when it comes to its first interest rate cut.
