MNI SOURCES: "Biggest Minority" Favours ECB June Cut

An early consensus within the European Central Bank is forming for a first interest rate cut of the cycle to take place in June, Eurosystem officials told MNI, but they added that signs of a significant further easing in the inflation outlook could still prompt the Governing Council to move in April.

While the “biggest minority” on the Governing Council is in favour of cutting in June, after Eurostat national accounts data released at the end of April provide a full picture on wage increases, as argued by chief economist Philip Lane, several sources pointed to the March projections as key for deciding on the timing and pace of cuts. A projection showing inflation sustainably at the 2% target by mid-2025 could open the door to an earlier easing, one source said. (See MNI INTERVIEW: ECB Heading For Spring Cuts-Ex ECB Economist)

“Given that our objective is based on the medium term, if the March forecast confirms an improvement in the inflation horizon, I think it will be time to propose cuts,” a second source said, adding however that “A consensus is forming regarding June.”

MARKET PRICING

Still, most officials said market pricing, currently implying about 140 basis points of easing by December, was overblown, and several stressed that cuts were likely to take place in careful, 25-basis-point increments. They also noted the potential for inflation surprises from worsening geopolitical risks even as the economy holds just above recession.

“It’s not necessary to cut at every meeting. You have to see what’s going on with inflation as you decrease the interest rate. It's possible, for example, to cut two times by 25 points each, then if inflation remains stable or increases a little bit you have to stop there,” one official said, assigning a probability of less than 50% to a 25-basis-point cut in April, with anything earlier than that very unlikely.

Next week’s Bank Lending Survey data is another key data point, and an extremely bad reading could also increase the likelihood of a rate move in April.

“But it would have to be credit-collapse bad,” a national central bank official said. “Personally I still think we hit 2% headline [inflation]no later than mid-2024 and we will be stuck in a tight range there or thereabouts through year end. Core will be heading the same way and all underlying readings will make a sequence of cuts -- whether every meeting or every quarter -- very easy.” (See MNI SOURCES: ECB Needs Sub-3% Core Inflation To Consider Cuts)

The official agreed that interest rate reductions are likely to be made in 25-basis-point increments.

“The only thing I think could trigger any 50 bps cuts is if inflation falls sharply towards 1%,” he added.

However another source argued that the longer the ECB waits before beginning to ease the more dramatically it may eventually have to act.

“If we have to do more than 25 at a time that would mean that we overtightened. And we may overtighten because we waited too long, not as a result of having hiked too much,” the official added. A cut could even be possible in March, he said, though he conceded that this was unlikely. (See MNI INTERVIEW: ECB At Risk Of Overtightening - Suedekum)

COMMUNICATION CHALLENGE

Market pricing for aggressive easing will present a communication problem for ECB President Christine Lagarde when she faces the press conference following the January meeting, one official said.

“No doubt she will be pushed and will have to address it,” the official said, adding “I'm still of the view we'll see two, probably three, cuts.”

Another official thought market easing expectations for the Federal Reserve might be exaggerated as well.

“I think they are wrong, because that would mean that you're going to have interest rates at less than 3% in the euro and less than 4% for the Fed rate. So very, very close to inflation, because inflation is not going to go down to less than 2%,” the source said. “So the question to the ECB’s Board members is what is finally the neutral interest rate, and whether this will reflect a shift towards positive real rates?”

However there is little agreement within the ECB as to the current level of the neutral rate, sources noted, with some thinking it has gone up and others that it has remained negative.

An ECB spokesperson declined to comment to MNI.