Dispatch€s from Frankfurt: ECB Review: Finger on the Trigger
ECB and Fed attitudes diverge again
Decidedly dovish meeting today, reflecting the challenges from the trade war. The ECB stands ready to act - aggressively, if needed - and now sees the outcome of the trade war as squarely disinflationary.
source: Charlotte Venema on Unsplash
The ECB delivered a “unanimous” 25bp cut – some governors raised 50bp but didn’t make the case for it according to Christine Lagarde – and dovish language today.
The governing council acknowledged “exceptional uncertainty” in the outlook due to the trade war. There is nothing in the statement to suggest that inflation remains in any way a worry for the ECB as inflation has developed in line with the projections and – once more – looks likely to settle on target. The statement recognizes that domestic inflation has declined (it used to say “remains high” for many meetings).
More importantly, it seems that at least in the near term, the council now sees the impact of tariffs as disinflationary on account of the hit to growth and the possibility Chinese exports are re-routed to the euro area (as I’ve been arguing since last year). She did acknowledge discussion in the council about whether the long term impact may differ from the near term one though.
President Lagarde stressed “readiness and agility” as an important new theme, suggesting if not a more dovish reaction function then at least more responsiveness to use all available instruments to deal with the fallout from the trade war on both the real and the financial side.
In principle it opens the door both for intermeeting action, as well as big action (perhaps a 50bp cut).
While I don’t think that the real-economy fallout from the trade war will necessitate either of these – there’s little that can’t be dealt with via a more gradual sequence of 25bp – the signal is nonetheless important: the ECB’s got the finger on the trigger. This signal should also be seen together with the soft pushback on exchange rate appreciation (it enters their assessment for inflation). I think the exchange rate is emerging as a major worry.
While Christine Lagarde explicitly avoided repeating that “the direction of travel is clear”, the sum total of the ECB’s posture as delivered today does point to further downside for rates. I continue to expect a further cut in June and another one in 2H, probably in September, for a 1.75% terminal rate.
The contrast to Powell yesterday is clear. The Fed is becoming more inertial as they attempt to maintain anchoring of inflation expectations while they implicitly prioritize the inflation part of their dual mandate. The ECB on the other hand is getting more ready to act, aggressively if necessary.
I think there’s more space here for near term tactical EURUSD downside.
Last but not least, when asked about whether she expects that the Fed would continue to provide dollar swap lines if needed, she responded indirectly, to the effect that there’s been good cooperation in the past and that she was confident this would continue.