ECB on a Tightrope: Will It Cut Rates?

In this day and age, expecting the unexpected has been a prudent strategy. The market is pricing in a 97.8% probability that the ECB Governing Council elects to cut rates by 25bps when it meets in two weeks, taking the target rate down to 3.75%. The market foresees another 25bps cut in October and a roughly 50% chance of a third cut in December.

Clearly a cut in June is almost a certainty, but similar to the stance we’ve taken with the Fed and BoE this year, we question whether the ECB will be as dovish going forward as the market is currently expecting.

The case for monetary easing is relatively simple – headline inflation has fallen from over 10% in Q4 2023 to 2.4% in April. Meanwhile, the economy is growing at a lacklustre 0.3% quarter on quarter, following contractions in the latter half of 2023. It goes without saying that all the member states could use a shot of adrenaline to aid growth and stop the economy sliding back into recession in the coming quarters.

However, implementing a series of rate cuts might be more complex, and the ECB faces a delicate balancing act.

• Global inflation: stubborn inflation, particularly in the US and UK, and aggressive rate cuts signalled by the ECB will likely weigh on a currency that is already under pressure. Whilst it will give economic growth a much-needed boost, it will also drive up the cost of imports, potentially leading to higher prices for consumers.
• Wage pressures: Eurozone unemployment remains at its lowest level since the inception of the single currency, suggesting upward pressure on wages. If consumers have more money in their pockets, it allows retailers to push prices up further, as ECB Vice President Luis de Guindos noted last week. His refusal to commit to further rate cuts after June reflects this uncertainty.