The European Central Bank will almost certainly lower interest rates by 25 basis points at its next meeting on June 6. The focus at the press conference is likely to be on what will happen in the months ahead. President Christine Lagarde is unlikely to explicitly signal another move in July, but she may give a gentle nod to more action in September.
Bloomberg Economics forecasts a cut of 25 bps in June, and, after a pause in July, more reductions of the same size in September, October and December. Financial markets have fully priced in a reduction in June and one more before the end of the year.
Members of the Governing Council have left little to surprise for June – even the hawks have been indicating a cut is most likely coming. The debate has moved onto July and we don’t think Lagarde will publicly take sides so early.
Lagarde will probably paint a picture of price pressures being reduced by decelerating wage and unit profit growth. She’s likely to downplay the acceleration in negotiated wage growth in 1Q24 shown by the ECB’s official time series.
The ECB’s staff economists may leave their inflation forecasts largely unchanged from March and the balance of risks could stay the same too. However, the GDP forecast for this year will probably be revised upward and the risks to the outlook for activity could be more balanced.
Broadcasting June Cut
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“Barring a surprise, the first rate cut in June is a done deal,” Banque de France Governor Francois Villeroy de Galhau said in an interview published on May 28. While their comments have been less forceful, several other policymakers have communicated the same message, including Lagarde, Chief Economist Philip Lane and Bundesbank President Joachim Nagel. The battle has moved onto what will happen in July and the hawks are already stating their opposition to another move that soon. Executive Board Member Isabel Schnabel has quashed the idea. Nagel and Dutch central bank governor Klaas Knot have also stated their opposition. However, Villeroy said a cut in July shouldn’t be ruled out.
Lagarde tries to seek consensus and we doubt she’ll come down on one side of the debate so early, especially as the Governing Council is claiming to “follow a data-dependent and meeting-by-meeting approach”. However, any nod to needing more data on profits and wages would suggest that she’s leaning toward skipping a cut in July and waiting for figures from the national accounts for 2Q2024, which will be published in September. We continue to think that the first couple of moves will coincide with those quarterly releases (and the fresh forecasts of the ECB’s staff economists).
Decelerating Wage Growth Most countries of the euro area have already released data on compensation per employee in 1Q2024 and they will be used to paint a picture of wage growth in the monetary union as a whole. The euro-area aggregate won’t be published until June 7 – the day after the ECB’s upcoming meeting.
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Data that we compiled from 16 countries point to pay increases in the euro area decelerating to 4.6% year over year in 1Q2024 from 4.7% in 4Q2023. The time series is moving in the right direction but not as fast as the ECB would probably like it to.
Fortunately, profit increases are no longer making the euro area’s inflation problem worse. Unit profits haven’t grown in recent quarters as quickly as they did for most of 2022 and 2023. We expect that moderation to persist this year.
Domestic Cost Pressure Has Eased
The ECB’s official time series on negotiated wage growth in the euro area showed an acceleration to 4.7% year over year in 1Q24 from 4.5% in 4Q23. However, one-off payments in Germany boosted the latest figure. The ECB published a blog post on the same day that the data on pay settlements were published. It looked at a variety of indicators, including the ECB’s wage tracker, which smooths out those payments. The authors concluded that “wage pressures look set to decelerate in 2024”. We expect Lagarde to reiterate that conclusion at the press conference on June 6. That moderation in wage and unit profit growth should cause services inflation to cool. It accelerated to 4.1% from 3.7% and surpassed the 4.0% where the figure had been stuck for five months before April but the rise was probably primarily caused by a base effect linked to the introduction of a cheap flat rate for regional transportation in Germany a year ago.
Steady Inflation Forecasts
Changes to the inflation forecasts of the ECB’s staff economists may be limited. Inflation outturns since the Governing Council’s last meeting are unlikely to have been cause for a revision to the forecast from March for price increases in 2024.
In addition, the impact from energy prices is likely to be small. We estimate that the ECB will probably have to revise up its assumptions for brent crude prices by about US$6 per barrel for 2Q2024 and US$4 per barrel for 3Q2024, with the shock eroding gradually afterward. Plugging those price movements into SHOK, our in-house model of the euro-area economy, we find that they should push up inflation by less than 0.1 percentage point in 2024 and act as a small drag on price increases beyond that.
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However, we still see downside risks to the ECB’s inflation estimates over the forecast horizon. We project price gains of 2.1% in 2024, 1.4% in 2025 and 1.6% in 2026. Those compare with the staff economists’ numbers published in March of 2.3%, 2.0% and 1.9%, respectively. Our view is that below-target inflation and dwindling domestic cost pressure will prompt three more rate cuts in the second half of the year.
GDP growth surprised to the upside in 1Q2024 and that should push up the annual estimate produced by the staff economists to about 0.7% from the 0.6% published in March. Further out, those numbers are more linked to the longer-term prospects for the economy and less likely to change.
We expect the risk assessment for inflation to be similar to what it was in April, when it was broadly balanced with risks both to the upside and downside. However, the ECB may shift the risks to economic growth to being balanced from being tilted to the downside. We think the economy will gain momentum throughout the year, as lower inflation supports household spending and easing financial conditions support investment demand, and recent data releases support that view.
