23 JAN, 2024
By Johanna Zidani from RankiaPro Europe
On Thursday, January 25, the first ECB meeting of 2024 will take place. The market consensus expects that the Governing Council of the European Central Bank will keep interest rates unchanged, as crucial data on economic performance, such as fourth-quarter GDP growth, and inflation rate in January, will not be released until January 30 and February 1, respectively.
Below, you can find the opinions of international fund managers on what they expect to happen at this Thursday's European Central Bank meeting.
It is widely expected that the Governing Council (GC) will keep its policy rates on hold at the January
Please find below what we expect:
In summary, and given what was shared at Davos, we expect that President Lagarde will continue to push back against bets on early and extensive rate cuts. At this meeting, with no fresh macro- economic projections, we do not expect any clear guidance on the timing or size of rate cuts this year due to the ECB’s data dependent approach and uncertainty (i.e., especially related to wages development). Nevertheless, we believe that the ECB communication will be balanced, evoking risks of overtightening and risks of premature easing. This committee may lead to a slight steepening of the interest rate curve and a moderate weakening of the Euro currency.
Following an overall favorable inflation data, markets have started speculating about ECB key rate cuts beginning in the second quarter. Recent comments from Governing Council members were more heterogenous and President Lagarde again emphasized the importance of this year’s collective wage agreements. Major latest agreements in France, Spain and the Netherlands were quite high and unlikely tamed concerns about medium term inflation. Therefore, at Thursday’s policy meeting we expect the ECB to adopt a wait-and-see stance emphasizing data-dependence once more. We continue to look for a first rate cut by June only and think that the narrative of the accompanying press conference will be consistent with this view.
We expect it to be a transitional monetary policy meeting in terms of concrete measures to be taken. The ECB will likely keep the deposit facility rate at 4%, maintaining the balance sheet reduction through lower reinvestments in the APP program. The most relevant aspect will be listening to Lagarde in the press conference, in case she provides some visibility regarding the start and pace of interest rate cuts in 2024.
In this regard, the market continues to anticipate significant interest rate cuts, around 50 basis points in June and more than 125 bps throughout 2024. Therefore, the discourse is likely to follow a consistent path with the statement in the last meeting and the messages conveyed since then, reiterating numerous times that the process will not be as swift as the market is anticipating.
Since the last monetary policy meeting, we have seen some less favorable inflation data than before. Additionally, geopolitical risk in the Red Sea has increased, with implications for global trade, which does not help gain visibility into future actions by the ECB.
Therefore, it is most likely that Lagarde will continue to provide a data-dependent approach as information becomes available (meeting to meeting), but always within a context of interest rate cuts. This aligns with the comments made by many members of the Governing Council in recent weeks.
We do not expect any significant announcements regarding balance sheet reduction, once the lower reinvestments in the PEPP have been communicated from the second half of 2024, with a complete cessation of reinvestments by the end of the year. This should not have a major impact on bonds, as reflected in the risk premiums of peripheral countries, which have narrowed since the last monetary policy meeting.
While the market appears a bit too enthusiastic about the continuation of rapid disinflation in the U.S., there is at least one element we haven't discussed that could foster "almost painless disinflation" in 2024, and that is productivity. In the third quarter of 2023, U.S. hourly productivity was 5.3% above its pre-Covid crisis level, and after a slow recovery in 2022, advancements have accelerated in 2023. This has allowed unit labor costs to start decelerating. Unfortunately, none of this is happening in the eurozone, where, on the contrary, productivity last summer (latest available data) barely exceeded its pre-crisis level and has started to decline again. This largely explains the ECB's nervousness about the inflation trajectory in the future. In fact, the eurozone faces a dual problem: wage growth remains very robust, and the institutional characteristics of the European labor market could make it more prone to prolonged price and wage equalization behavior, while declining productivity would further increase inflationary pressure by raising unit labor costs even faster than wages.
Although we understand why the ECB is concerned about the risk of a second wave of labor cost-driven inflation, there is an equally powerful force that can play in the opposite direction: the cushioning impact of poor demand-side conditions on profits. The ECB is more focused on the former than the latter because it expects an economic recovery at some point in 2024. We are more cautious. What we mean is that we are less concerned about inflation risks in the eurozone than in the United States precisely because we expect mediocre growth in Europe. From a normative standpoint, this would make us sympathetic to the March cut..., but from a predictive standpoint, given the analytical decisions made by the ECB, we still do not expect that move before June.
At the last press conference in December 2023, ECB President Christine Lagarde could still say that it is too early to talk about interest rate cuts. However, this is a topic that now dominates all comments from central bank governors in the eurozone. For some, it is generally too early; for others, more data is needed, or they no longer see risks from the wage side. Currently, there is a wide range of opinions within the Governing Council.
It is unlikely that the January 25 meeting will change much, as the truly important data on economic performance (GDP growth in the fourth quarter) and January inflation will not be published until January 30 and February 1, respectively. Therefore, the ECB is likely to continue emphasizing its data dependence in the press conference but may also open up to interest rate cuts in the near future.
Even if the ECB does not commit to a date, we believe there are compelling reasons for a first cut in June 2024, when data on wage developments in the first quarter should also be available, and there will be more clarity on the inflation trend in 2024. We do not yet share the optimism of many market participants that the ECB will cut rates very rapidly and significantly. As the ECB wants to avoid mistakes at all costs, we maintain our view of gradual rate cuts in 2024.
Our baseline hypothesis remains a significant slowdown in growth in major economies, and recent data - particularly in the eurozone - is consistent with that expectation. While it is clear that inflation is decelerating, it is still uncertain whether it will fall back to central banks' policy targets.
We believe that major central banks have completed their tightening cycles, although they are likely to remain vigilant about inflation risks for several months. The Federal Reserve is most likely to raise rates, and the ECB the least likely. However, central banks will want to preserve maximum flexibility as long-term inflation prospects remain uncertain. So, at least for now, we expect data dependency to continue and the era of forward guidance to come to an end. This means we need to prepare for a sustained period of higher interest rates, even as economies continue to slow down.
By Marco Mencini
By Christoph Siepmann