The European Central Bank’s January meeting saw President Lagarde hold the line firmly against an early cut in interest rates. While the odds of a soft landing for the developed world are increasing, European growth is sluggish and we think policymakers will soon be under pressure to cut rates before their US counterparts.
At its first meeting in 2024, the European Central Bank (ECB) kept its borrowing costs unchanged, in line with consensus and our expectations. The policy statement saw some modest changes, sounding somewhat more optimistic on inflation dynamics.
The reference to elevated domestic price pressures was removed and instead the ECB noted the ongoing "declining trend in underlying inflation". The statement reiterated that the forceful transmission of higher interest rates into financing conditions continues.
The key focus for investors in this meeting was on the guidance that the Governing Council was prepared to provide on the potential timeline for interest rate cuts. In the run-up to the meeting, some ECB officials pointed to June as the earliest meeting that could herald the start of the easing cycle. As expected, in the press conference, President Lagarde pushed against market expectations of earlier cuts (April), stressing the ECB remains data dependent, not date dependent, and the rate cut debate remains "premature".
The summer timeline is partly guided by data on negotiated wages which will only be available in full in late April, in time for June's meeting. President Lagarde said they are seeing some stabilisation in their wage tracker, but additional data is needed for a fuller picture - the ECB is prepared to wait for more information before moving the debate towards easing.
The outlook for the developed world has shifted significantly in recent months and we now assign a 45 per cent probability to a soft landing scenario - where inflation fades back to target and growth settles at or modestly below trend - continuing throughout 2024.
There are still risks, however, and Europe is among the most exposed to a slide into recession. The bank, on the evidence of President Lagarde’s press conference, seems intent on holding the line; we think on balance they should be the first of the big developed world central banks to move on rates.
As to the detail, while European Area (EA) growth signals remain very weak, carrying over the sluggish - or mildly negative - momentum from 2023, there are no signs of significant deterioration in leading indicators in early 2024. Industrial activity remains subdued, but the services sector has picked up modestly and consumer surveys are showing signs of improvement. Falling inflation is boosting real wages and real disposable incomes, adding to consumer confidence. While this improvement is encouraging, we believe risks to growth are skewed to the downside, as tight policy continues to have an impact on the real economy. External sources of support, including China's economy, also remain weak.
Against these broader disinflation dynamics, continued strength in the EA labour market, highlighted by President Lagarde in the press conference on several occasions, is still fuelling concerns about elevated wage growth. These concerns will continue to dominate ECB officials' minds in the coming months until indicators of wage growth point to a sustainable disinflation trend.
With the Red Sea disruptions also presenting upside risks to inflation, the ECB is signalling caution against premature cuts. With this in mind, we think a March rate cut is unlikely but a move in April does not seem to be completely off the table. Faster transmission of policy to the real economy, leading to a deterioration in growth, combined with rapid disinflation from here, may well open the door for an earlier cut than officials are currently banking on.