Beyond the Headlines | 14 Jun 2024

ECB embarks on rate cutting path, but at an uncertain pace | Beyond the Headlines

Angel Talavera

Angel Talavera

Head of Europe, Macro

Our latest video for asset managers

Following the June ECB meeting, this was the first time the ECB lowered its policy rate in five years, but the move came as no surprise given the central bank had provided plenty of clues ahead of the meeting. The big question is what happens next?

In this week’s Beyond the Headlines, Angel Talavera, Head of Europe Economics, discusses the uncertainty around the future path for policy rates.

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Hi, I am Angel Talavera, head of Europe Economics at Oxford Economics.

The ECB cut rates by 25 basis points last week. This was the first time the ECB lowered its policy rate in five years, but the move came as no surprise given the central bank had provided plenty of clues ahead of the meeting.

The big question is what happens next. President Lagarde has said she doesn’t think that forward guidance is helpful at the moment given the high level of uncertainty. This means there is an unusual level of uncertainty around the future path for policy rates and the ECB’s reaction function.

Ultimately, the ECB will continue to be guided much more by what the data dictates than by what their forecast say. But even under this premise, there is a lot of data to choose from. The ECB formally targets headline inflation, but has indicated it is monitoring a much larger set of indicators to guide its policy. These include core inflation, services inflation, wage growth and profits, among others.

Based on this data dependence approach, we have a forecast for rates that is more dovish than what the market anticipates. This is because we expect inflation to fall below the 2% target next year. If our forecast is correct and the ECB is true to its word, this should kickstart a series of rate cuts. But the level of dissent within the council and the hawkishness of its communication means there is a substantial risk that the central bank will cut rates at a slower pace, even if headline inflation falls substantially, if other measures fail to do so. But by focusing too much on lagging indicators such as wages, we think the ECB is at risk of committing a policy mistake if it misjudges the magnitude of the disinflation process and keep rates too restrictive for too long a period of time.


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