MNI INTERVIEW: ECB Likely 1st Big Central Bank To Cut-Moody's

The European Central Bank could be the first major central bank to cut interest rates, as falling energy prices, the lagging effect of previous monetary policy tightening, and a disinflationary impact from China’s post-Covid reopening drive both headline and core inflation closer to negative territory over the next two years, a senior Moody’s economist told MNI

March’s Eurosystem staff macroeconomic projections could see the ECB’s headline inflation forecast for 2023 revised down from the 6.3% foreseen in December, though there will be an upward revision to the 4.2% core inflation figure, Kamil Kovar, lead economist for eurozone forecasting at the ratings agency, said in an interview. March’s GDP growth number for 2023 will be broadly in line with the 0.5% foreseen at the end of last year, he said.

Moody’s expects European rate-setters to hike by 50bps in March and 25bps in May, before concluding the tightening cycle as early as June at a peak of 3.25% Kovar said. (See MNI SOURCES: 100bp Gap Between Hawk-Dove ECB Peak Rates)

“At that point, headline is going to be much lower than the peak, core should start to show signs of significant decline, and June’s [Eurosystem] projections might reflect that. We really don't see hikes from September onwards. That would really surprise us at this point. We actually think the ECB might be the first one to reverse course,” he said.

DISINFLATIONARY IMPULSE FROM CHINA

Both key inflation measures could dip below the ECB’S 2% target next year, Kovar said.

“I think 2024 is where the question of inflation is going to be decided. We are more of the mind that in 2024 we will likely see sub-2% inflation rates at some point. Not in terms of the annual average; in some months we will probably see that. And that might even apply to the core.”

Higher core inflation has been more a product of recovering demand than the spike in energy prices, said Kovar, who argues that Europe’s economy and bank lending has yet to feel “even half” of the impact of tightening effect of previous tightening decisions.

While China’s reopening will fuel demand for raw materials, Kovar is sceptical that it presents an upside inflation risk.

“I [do not] think there is going to be the same cycle in terms of goods consumption. If anything, it's going to be a shift from goods to services. So, overall - and putting commodities to one side - I would consider China’s reopening to actually have a downward effect on inflation.”