At Thursday’s meeting, we expect the ECB to lower the deposit facility rate by 25 basis points, to 2.5%. The new staff projections will likely show lower near-term growth and a broadly unchanged inflation trajectory. Weak growth and inflation projected at target this year argue for a policy rate close to neutral, despite still elevated domestic inflation.
Since December, the ECB no longer aims for sufficiently restrictive policy, but rather intends to deliver an appropriate policy stance. As a result, the discussion about a suitable neutral policy rate configuration has gained traction within the Governing Council (GC) and disagreement has emerged.
On the hawkish side, Executive Board (EB) member Isabel Schnabel believes a discussion about pausing the cutting cycle is warranted fairly soon. On the dovish side, EB member Piero Cipollone not only thinks that the current policy setting is overly restrictive, but also urged the ECB to ensure that rate decisions adequately compensate for the tightening induced by the reduction of the balance sheet. Consequently, rate cut decisions beyond March are less likely to be unanimous.
Given uncertainty around the neutral policy range and still too high domestic inflation, largely reflecting persistent price pressures in the services sector, we think policy rates are likely to continue the descent in a cautious fashion. Markets are currently pricing a terminal rate of around 1.9%, which remains broadly consistent with our estimates for a neutral policy rate for the Euro area.
Nevertheless, we see additional downside risks to Euro area growth post US election, and potential for lower terminal rates than currently priced in. The present environment of elevated uncertainty leaves no room for forward guidance, and we expect the ECB to continue to stress that decisions will remain meeting-by-meeting. Reiterating that the data flow over the coming months will decide the speed and scale of monetary easing at future meetings.
By Konstantin Veit, Portfolio Manager at PIMCO
