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In a move that surprised almost no-one, the ECB has held rates once again today, maintaining the deposit rate at 4.00% in line with market consensus and our pre-announcement call. Given these expectations, the focus for many, including ourselves in advance of this decision, was not if the ECB would cut rates today, but when in the future they might begin.
Following a raft of commentary from ECB speakers at Davos last week, however, we were doubtful that any further clarity would be forthcoming. Policymakers initially met this expectation in full, delivering a statement that was entirely devoid of new guidance. Indeed, the only change of note was to recognise an uptick in headline price growth, the result of energy-rated base effects, which had been flagged in advance at the December meeting. The lack of push back against market expectations was interpreted dovishly by markets, however, with traders accelerating ECB easing bets which in turn weighed on the euro.
Indeed, perhaps the most surprising point of today’s commentary came not from what was said, but what wasn’t. The willingness of policymakers to look through the recent uptick in inflation scans as dovish to us at the margin. This is especially true in light of yesterday’s eurozone PMIs, which indicated that, despite growth indicators remaining poor, there were also signs that price pressures had once again begun to tick up. Such a fact would have surely been worth a mention if the central bank was set on pushing back rate cut expectations.
Given that today’s communications failed to do so, even when President Lagarde was directly challenged on the PMI figures in her press conference, this suggests to us that the ECB is broadly comfortable with recent market pricing that looks for between five and six rate cuts this year.
The lack of pushback on easing expectations was to us the standout feature of President Lagarde’s press conference. Granted, she did stress that it was too soon to talk about rate cuts at this meeting, and stood by her comments at Davos last week which had suggested that policy easing could begin in the summer. But it was also notable that she accompanied this with a reiteration of the Bank’s data dependent approach to setting policy. Specifically, whilst some upside risks to inflation were flagged, including current developments in the Middle East, the balance of risks highlighted appeared tilted towards a faster than expected slowdown in price growth. In particular, Lagarde noted that the recent rebound in inflation was weaker than expected, with almost all underlying inflation measures falling in December and risks to growth remaining tilted to the downside.
In our view, having earlier recognised that market expectations had moved sideways since December, and then largely focused on signs of progress in the data, this seems to leave the door open for earlier rate cuts than Lagarde’s prior comments suggest.
In our view, the eurozone economy has likely slowed faster than ECB officials are willing to publicly acknowledge, and this should in turn lead inflation to cool faster than predicted. Given this, and assuming that the ECB is as data dependent as it professes, we think April remains the most likely meeting for a first rate cut to be delivered. This opinion also appears to be shared by markets today as well. Having seen the odds of an April rate cut at just over 60% heading into today’s meeting, swap pricing now implies a more than 80% likelihood for this outcome. The acceleration of ECB easing bets naturally weighed on the euro following the announcement, with EURUSD falling 0.4%. We think this likely has further to run over coming weeks too. With more scope to price in rate cuts from the ECB, and Fed expectations likely to move in the opposite direction, we continue to see EURUSD sinking towards our Q1 target of 1.05.
Markets took a dovish view of today’s ECB commentary, now seeing a more than 80% chance of an April rate cut, despite policymakers previously suggesting that this would not come until the summer
Author:
Nick Rees, FX Market Analyst