The ECB’s debate over July rages on

With most ECB members publicly accepting that they will cut rates in June, the debate has swiftly moved onto the July meeting, which is being hotly contested between the doves and the hawks.

Dovish members such as Banque de France Governor Villeroy de Galhau have been arguing for a more pragmatic approach, cutting rates multiple times at first to avoid having to embark on more substantive easing to a lower terminal rate over the medium-term. On the contrary, ECB hawks such as the Bundesbank’s President Nagel and Latvia’s Muller have argued against back-to-back cuts, stating that inflation risks are still tilted to the upside. Ahead of what is set to remain a key batch of Q1 wage figures in May, today’s eurozone data hasn’t necessarily settled this debate.

On an aggregate basis, inflation broadly met expectations, printing at 0.6% MoM and 2.4% YoY.

This will be somewhat relieving for the doves within the Governing Council as early Easter effects posed a risk of an upside surprise, as did national HICP readings over the past 24 hours.  However, the hawks will find comfort in the fact that core inflation modestly beat expectations, printing at 2.7% YoY to mark just a 0.2pp drop from March. The advance reading of Q1 GDP data similarly supports arguments for both sides. The hawks will point to the fact that growth printed above expectations across all four of the continent’s largest economies, leading to a positive surprise in the aggregate measure that showed the economic bloc expanding by 0.3% QoQ, exceeding expectations of more moderate growth of 0.1%. In isolation, this suggests that the latest upswing in April’s PMIs occurred from a higher base rate of growth, reinforcing the idea that the demand outlook remains durable and could foster persistent inflation pressures. However, the doves will argue that the growth figures were boosted by a downward revision to growth in the fourth quarter, which at -0.1% QoQ now shows the eurozone recording a technical recession in 2H23.

Country-specific releases offer little further evidence in either direction. Southern European economies once again did the heavy lifting, with GDP rising by 0.7% QoQ in Spain and Portugal, 0.3% in Italy and Belgium, and 0.2% in Germany, France, and Austria.

The flash measure doesn’t contain expenditure breakdowns, but details from the French and Spanish data suggest that consumer spending is rebounding, in line with the anecdotal reports in the latest PMIs. Despite this, and the fact that the overall level of growth has exceeded the ECB’s forecast of just 0.1% QoQ, this isn’t a homerun for the ECB hawks as strength in consumption at the start of the year is starting to become a seasonal red herring for Europe’s growth outlook. Moreover, the European Commission’s Economic Sentiment Indicator was disappointing in April, with services outperforming manufacturing once again.

On the whole, today’s data leaves the trajectory for policy rates in Europe in limbo ahead of key wage data released next month.

This is a view shared by markets, where a June cut remains 90% priced in, but a follow-up cut is discounted at just 30%. For EURUSD, the mix of somewhat better inflation outturns and stronger growth is providing a marginal boost and should add another layer of protection around the 1.07 handle, even if it only proves temporary.

Author: 

Simon Harvey, Head of FX Analysis

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