Dispatch€s from Frankfurt: Curiosity Won't Kill this Cut
June ECB meeting preview
Welcome to the first edition of Dispatch€s from Frankfurt – the special suite of Thin Ice Macroeconomics devoted to regular updates on the European Central Bank and its monetary policy. Readers will forgive that the section is more specialized (and takes more for granted) than the blog in general.
Summary. Recent data have been broadly consistent with the ECB’s central scenario for a decline of inflation to target. This should allow the governing council to (i) execute on the all-but-preannounced rate cut next week (ii) without pre-committing to “a particular rates path” in the statement, yet (iii) maintain a vague easing bias in the press conference.
Narrative intact. The ECB governing council’s central scenario has been one of convergence of inflation towards its target over the next year-and-a-half – forecasts produced by ECB staff in March have inflation sustainably at 2% from mid-year 2025.1
Since March, the data have done little to challenge this central scenario. While last week’s euro area data on negotiated wages for Q1 showed an uptick in the annual rate, this was largely due to one-offs in Germany. In various public pronouncements, neither doves nor hawks2 have expressed much concern over the wage numbers.
Somewhat higher price inflation in May is to be expected given base effects, with some added tolerance being suggested by ECB rate setters’ consistent message that the path of disinflation was going to be bumpy and not linear.
June cut “done deal”. Overall, the new vintage of staff forecasts should feature only minor changes – fulfilling the necessary-and-sufficient condition for the rate cut to take place. As Banque de France governor Villeroy de Galhau said, it would take a “shock” to derail it: the bar is very high for the cut not to materialize.
No pre-commitment in statement. With the central scenario intact, I expect no major changes to the monetary policy statement. It should maintain that the ECB is “not pre-committing to a particular rate path”. This phrase is probably what the hawks got in return for agreeing to have the council all but pre-announce a June rate cut in the April meeting. It would be a major dovish surprise if it’s not there when the cut is actually delivered.
Press conference: easing bias to stay. In the presser I would expect President Lagarde still express a nuanced general easing bias (April: “The direction is rather clear, but there is no pre-commitment to any particular path”). After all, the hawks have conceded two cuts for this year (e.g. Belgian governor Pierre Wunsch “the first two rate cuts are quite easy” in April; Bundesbank president Joachim Nagel on Friday talked about the next move being in September).
I also read chief economist Philip Lane’s FT interview Monday in this mold (“[t]he data flow over the coming months will help us decide the speed at which we remove more restrictiveness” – the speed, not whether restriction will be removed). I think it would take a negative surprise in the data to have the ECB do fewer than two cuts this year.
In short, if there is broad agreement among rate setters that the central case is intact, then a generalized easing bias should remain in place. Absence of such an easing bias would be a hawkish surprise to me.
Beyond that, I think it makes sense for the council to play for time. A July cut seems unlikely. Villeroy de Galhau is consistent with the ECB’s communications framework when he points out that data dependency means a July move should not be excluded. However, I would interpret this remark as tactical, to help the push for a September cut. Ultimately, it should be the data until then, along with the next vintage of staff forecasts, that decide whether there will be a cut in September.
Why I’m still sticking to three cuts this year (June-September-December), although I recognize risks are for two cuts only:
I think the Fed-dependence of the ECB is overstated (as is the inflation impact of the exchange rate), and market pricing of the ECB has arguably been influenced by the outgoing tide of Fed (as well as Bank of England) interest rate cuts of late.
While economic activity is likely to continue surprising to the upside going forward, that should herald a cyclical productivity recovery: firms have hoarded labor while the economy was weak over the last several quarters. That is, the upturn in the data is not unequivocally hawkish.
But I am not, in general, more dovish than the market. I remain convinced that the structural tightness of euro area labour markets results in higher bargaining power for workers and hence higher wage pressures and/or labour shares of income, in turn requiring higher interest rates. But that’s a topic for another day.
While the governing council of the ECB does not endorse the ECB staff forecasts, they tend to be the reference scenario in the internal and public debate.
I generally don’t find the ornithological categories of “hawks” or “doves” very helpful as they suggest almost innate attitudes on behalf of policy makers, but I won’t attempt to swim against the tide in this blog!