European Central Bank: Closer but not done

The economist view – Melanie Baker, Senior Economist

The European Central Bank (ECB) were almost unanimously expected to cut 25 basis points today by forecasters. That followed commentary from ECB policymakers (and, arguably data) that had pointed that way in recent weeks. This week’s rate cut takes the deposit rate to 3.00%. My forecasts currently have the ECB cutting to 1.75% in 2025 and I can’t see anything in this statement that knocks this off track, but there is plenty of uncertainty ahead for the euro area (and global) economy (a point ECB President Christine Lagarde acknowledged in the press conference too).

More confident on inflation and a few dovish tilts

There wasn’t enough here to suggest that they are about to step up the pace of rate cuts, but there was enough I think to stick to a central case where the ECB continue cutting at a similar pace in coming months:

• There was a sense of growing confidence around the inflation outlook. In the statement they continued to note that domestic inflation remains high but attribute that “mostly” to wages and prices in certain sectors “still adjusting to the past inflation surge with a substantial delay.” Unsurprisingly then, they also continue to see the disinflationary process as “well on track”.  President Lagarde pointed out that inflation in their projections has converged towards 2% for six consecutive forecast exercises (these are done quarterly) and with trends in wages, profits and productivity all heading in the right direction to meet the inflation target.
• There was also what looks like a dovish shift in the statement. Although they still see current monetary policy as restrictive, they dropped the line in the statement which previously said “It will keep policy rates sufficiently restrictive for as long as necessary” to achieve the inflation target in the medium-term.  Lagarde later talked about dropping this sentence in the context of all the progress made from the period when inflation was very high and risks to inflation were one-sided.
• President Lagarde also acknowledged that there were some discussions of proposals to cut 50bps.
• The staff inflation forecasts aren’t much changed from December but do show core inflation a tenth below target in 2026 (and 2027) from 2.0% previously. Headline inflation is a touch lower this year and next on staff forecasts but after 1.9% in 2026 (that forecast is unchanged) now shows a bit of a rise in 2027 above target to 2.1%. Given staff see core inflation below target at that point, I wouldn’t read much into that and Lagarde signalled that the rise reflected the expanded EU Emissions Trading System becoming operational. ECB staff have also revised down their growth forecasts and see risks to growth as to the downside.

But still caution on rate cuts (not sounding ready to step up the pace)

Services inflation remaining around 4% however sounds like it remains a key reason why they aren’t “totally confident”. At one point, Lagarde said that: “Let's face it, when you still have 4.2% domestic inflation and wages of which the growth is slowing down, you have to be very cautious.”  

The risks to its medium term price stability goal of 2.0% are now two sided, not least due to the increased uncertainty arising from geopolitics and the incoming US Administration early in the new year.

It would be helpful to know where neutral is – but Lagarde remains non-committal

Lagarde was cagey on the question of where neutral is. We may be starting to get close to neutral rates – or more likely close to a plausible range for neutral in the view of some Council members – with the deposit rate now at 3.00% (though I still think neutral is closer to 2.00% and Lagarde in the press conference flagged a staff report a year ago that had numbers varying from 1.75-2.5%).  Lagarde said they have not discussed the neutral rate in the last couple of days. She did, however, say that she will give a speech on Monday that “really dissects and in great detail this issue of how restrictive and the sort of the direction forward.” She also said she thought that as they get closer to “where it eventually is” that they will probably debate the neutral rate more.

Still meeting-by-meeting and data led

They still say that they will follow “a data-dependent and meeting-by-meeting approach” and that they are “not pre-committing to a particular rate path.”

The government bond manager view – Gareth Hill, Senior Fund Manager

“Closer but not done” was the takeaway phrase from the ECB’s December Monetary Policy meeting of its Governing Council. They lowered rates by 25bps for the fourth time this year, and acknowledged that whilst rates do remain restrictive, they do not have to remain so going forward. The risks to its medium-term price stability goal of 2.0% are now two sided, not least due to the increased uncertainty arising from geopolitics and the incoming US Administration early in the new year.

The case for a larger 50bps rate cut, whilst was discussed by council members, a rate cut of 25bps was deemed more appropriate. Whilst all the key measures that the ECB look at are heading in the right direction to allow for further policy easing, there was once again a strong commitment to a data dependent approach and a re-iteration that they are not pre-committing to a particular rate path. The target of price stability remains their sole aim, and any concerns over other macroeconomic variables such as growth lie with individual member states to address with their domestic policies, including fiscal policy.

Despite acknowledging uncertainty arising from politics in individual member states, Lagarde refused to be drawn into commenting on any specific country, though did suggest a hope that the four remaining states yet to submit a budget for 2025 would be able to do so. On the issue of potential tariffs being imposed by the new US Administration, Lagarde conceded that this could turn out to be inflationary, though the uncertainty which they could generate may equally have a disinflationary impact as consumer spending is impacted as a result.

Further out along the yield curve, bonds performed poorly, perhaps suggesting that the ECB had not done enough at this meeting

So how did the market react to this? Going in to the meeting, a rate cut of 25bps was fully priced, but the market jumped on the removal of the phrase referring to monetary policy having to remain “sufficiently restrictive” and immediately priced a jumbo 50bps rate cut for the next meeting at the end of January 2025. Further out along the yield curve, bonds performed poorly, perhaps suggesting that the ECB had not done enough at this meeting and the attempt by Lagarde to strike a balanced tone, may have backfired and been interpreted as being unduly hawkish. Anyone hoping for a smooth glidepath in government bond yields into the holiday season will have been disappointed.

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