Dispatch€s from Frankfurt: Landed, But Not Moving off the Beaches Soon

ECB meeting review

Despite the rate cut, the “bump in the road” resulting from the near-term upward revision of wage, labour cost, and core inflation pressures seems to have made the ECB less inclined towards further cuts in the near term. September is more likely than not a skip, in my view, making for two cuts only this year, although I still expect five cuts by end-25. To use a D-Day analogy, the ECB has landed in rate cut country, but may not be moving off the beaches soon.

Bump in the road unsettles driver. The key to today’s communication seems to be the staff forecast and its upward revision in core and headline inflation pressures for 2024 and 25. The other side of this coin was an upward revision in employee compensation, which directly translated into higher expected unit labor cost growth. Yet both headline and core forecasts end up in the same place for 2026, at 1.9% and 2.0%, respectively.

That is, the message from the forecast is that there is a bump in the road ahead, but the destination is the same. Nonetheless, this extra bump in the road is hawkish: in conjunction with a plethora of mainly upside risks to inflation, it seems to have made the governing council more careful about cutting rates near term.

Communications conundrum. President Lagarde made as good a job as it was possible to make of the complicated communications challenge in front of her: (i) to declare that confidence in the outlook had increased – and thus that the criterion for today’s rate cut had been met – despite the fact that (ii) the near term inflation outlook had been revised upwards. (Readers will forgive me for repeating that the ECB should resist the forward guidance temptation.)

Diminished confidence. However, my takeaway from the press conference was of ultimately diminished confidence in the ECB’s central scenario of inflation at 2%. The tone of the presser was more hawkish than last time as well as more hawkish than I expected, even conditional on the May inflation data. While there were nods towards an easing bias (“far away from neutral”, “strong likelihood” the ECB is in the dialing back phase), my impression was that the ECB President had a lot less conviction this time, instead highlighting that speed and time of arrival of any further cuts were unclear.

September skip likely. The destination in the staff forecasts has not changed – inflation is expected to come in line with the target in 25Q4 – and the overall thrust of the numbers is in line with my narrative of a structurally tight euro area labor market limiting the number of cuts. However, I saw the latter as more of a “sting in the tail” story for next year. Today’s meeting therefore doesn’t change the total number of cuts I expect by end-25 (five, to a level of 2.75%). However, it makes September a close call, and, after what we heard today, I think a “skip” is more likely than not, hence resulting in only two cuts for the year (I never thought a July move was particularly likely).

Foto credit: Charlotte Venema via Unsplash

Today being the 80th anniversary of the Normandy landings, I would like to solemnly commemorate all those who sacrificed so we can be free today.