Ahead of the ECB’s interest rate decision this Thursday, two Vanguard economists have shared their thoughts and expectations with us as follows:
Commenting on the ECB’s upcoming rate decision, Jumana Saleheen, Head of Investment Strategy Group, and Chief Economist at Vanguard Europe, said:
“We judge that despite being bumpy, inflation is on track to return to target by year end. That view underlies our expectation that the ECB will cut three times before the end of 2024, with the first move coming next week.
“Services prices have proven especially stubborn since the start of the year and energy inflation saw a resurgence due to the significant fall in the price of oil which occurred last May – so called base effects. Having said that, we have long warned that services inflation tends to be stickier than other components of inflation, such as food, energy and goods inflation. Our expectation is that easing in the euro area labour market will allow for a moderation of wages that will eventually feed into services price inflation.
“On the growth front, we believe that the ECB will bring up their GDP forecasts for this year, on the back of the strong GDP print for Q1 of 0.3% (QoQ). The Bank’s March projections showed annual growth at 0.6% in 2024 and 1.5% in 2025. At Vanguard, our view is that the eurozone will grow by 0.8% in 2024 and 1.2% in 2025. The ECB is likely to move its forecasts closer to ours, front-running some of the growth they expect in 2025 into 2024.
“On inflation, the forecasts are less likely to change, given that both headline inflation and core, which excludes energy and food prices, came broadly in line with their March projections. Moreover, the recent decline in oil prices has significantly reduced the prominence of this risk to the inflation outlook.
“We are quite optimistic that the ECB will sustainably achieve the inflation target of 2% by 2025 at the latest. We expect that headline inflation will get to target by the last quarter of this year and core inflation will get to 2% in the first quarter of 2025. These forecasts are based on our bottom-up model of the different components of inflation and linking them back to their underlying drivers.”
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Also commenting on the ECB’s announcement this Thursday, Shaan Raithatha, Senior Economist, Vanguard, Europe, added:
“The start of the ECB’s easing cycle at the June meeting later this week has been widely signalled by the Governing Council in recent weeks. Expect a 25-basis point cut to all three of its main policy rates: the deposit facility rate, marginal lending facility and main refinancing rate. At the time of writing, markets have fully priced this.
“However, the pace of easing thereafter is less certain. May’s CPI surprised to the upside, driven by services, whilst food, energy and core goods prices remain well behaved. Though we are still awaiting the breakdown, it seems that base effects related to the timing of Easter and the introduction of Germany’s cheap public transport ticket last year cannot explain all the upside surprise. Higher underlying services inflation, coupled with firmer wage and GDP growth in Q1, raises the risk that the ECB will cut rates at a slower pace than the quarterly cadence we’ve currently pencilled in.
“That said, we maintain our view of sequential quarterly cuts for three reasons. First, high-frequency indicators suggest wage growth will decelerate meaningfully in the coming months. This is shown by both the ECB’s and Indeed’s wage trackers and is a view shared by key Governing Council members including Philip Lane (see his recent FT interview). This, coupled with the recent moderation in price surveys from both the European Commission and PMIs, gives us conviction that services inflation should start easing soon. Second, we buy into the argument that as inflation has fallen considerably in the recent months, the ECB can justify a lower nominal policy rate whilst still maintaining the same amount of real restriction. And third, we note that even traditional hawks on the committee are communicating an expectation of multiple rate cuts later this year. For example, Dutch Governor Klaas Knot signalled three to four cuts in 2024 would be consistent with optimal policy based on the March projections, whilst Austrian Governor Holzmann endorsed a rate cut on Thursday and expects a total of two to three by December.
“If we are right, quarterly 25 bps cuts would leave the deposit facility rate at our (and the ECB’s) assessment of neutral (2-2.5%) by the end of 2025.”
Bottom-line: The ECB will cut its main policy rates by 25 basis points on Thursday, thereby kick-starting its easing cycle. We expect a quarterly cadence for future cuts, which would leave the deposit facility rate at neutral (2-2.5%) by the end of 2025. However, risks are skewed towards a slower pace of easing given increased momentum in services inflation, wage growth and economic activity.
