As the European Central Bank (ECB) convenes in Frankfurt this week, its policymakers will be acutely aware of the divergence between market expectations and their own views on the appropriate timing of interest rate cuts.
Last week, several members of the ECB’s governing council, including President Christine Lagarde, publicly stated their expectation that the earliest decision to commence reducing borrowing costs would likely occur during the summer.
While the ECB remains cautious about growth expectations, it is not inclined to ease its stance on inflation. The minutes from the December meeting indicated that discussions on rate cuts were still far from taking place. This is unlikely to change at the upcoming meeting on Thursday.
When it comes to the structural weakness, the central bank has habitually overlooked the potential risks linked to the eurozone’s economy. Nevertheless, there appears to have been a change in this stance during the December meeting, as expert forecasts now include a more conservative estimate of potential growth in the eurozone.
In terms of inflation, the deliberations on its drivers and projections were largely unanimous in the December meeting. The deflationary trend was acknowledged, and there was a strong emphasis on the importance of actual inflation outcomes. It seems that the ECB currently views the actual inflation figures as the primary factor shaping inflation expectations.
Read more: ECB holds interest rates steady: When can we expect cuts to start?
Investors anticipate an imminent rate cut
Bond markets have responded by slightly reducing the expectations for monetary easing by the ECB this year. However, investors still hold an 80 percent probability of a rate cut in April and anticipate a total reduction of 1.3 percentage points throughout the year.
According to Marco Valli, economist at UniCredit, Lagarde is expected to reiterate that the ECB is not yet prepared to discuss interest rate cuts. Valli suggests that an April rate cut would only be implemented if an unforeseen disinflationary shock were to occur.
Some economists believe that eurozone inflation may be more persistent than anticipated, citing factors such as increased shipping costs due to incidents in the Red Sea, a resilient labor market driving wage growth, and recent improvements in financial conditions.
However, others argue that falling European wholesale gas prices, continued decline in goods producer prices, and weak economic growth, particularly in Germany, suggest that inflation is likely to fall short of ECB forecasts.
Katharine Neiss, economist at PGIM Fixed Income, highlights that the rapid deterioration in economic activity towards the end of the previous year has heightened the risk of the ECB having tightened monetary policy too aggressively in 2023.
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