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ECB Rate-Cut Expectations Start to Unravel Before First Move

(Bloomberg) — Strong economic data and vocal European Central Bank hawks are pushing some analysts and investors to waver in their expectations for interest-rate cuts this year.

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While most economists still foresee quarterly reductions following this week’s initial move, some reckon sticky inflation, rapid wage growth and surprisingly robust euro-zone output will constrain monetary loosening.

Traders, too, have pared easing bets, reinforced by Executive Board member Isabel Schnabel and Bundesbank President Joachim Nagel seeming to take July off the table, as Austria’s Robert Holzmann said two decreases in 2024 may suffice.

Cautious officials fret that lowering borrowing costs at consecutive meetings could prompt markets to take that pace as their baseline. They may also have less confidence than some of their colleagues that ECB policy can truly diverge from the Federal Reserve, which is likely to stay on hold for a while yet.

“We’ve been comparatively hawkish with our expectations since last year of only three 25-basis-point cuts for this year, but the risk for these expectations remains decidedly for fewer rate cuts — not more,” said Dennis Shen, an economist at Scope Ratings. “The ECB will reasonably want to avoid the mistake of cutting too aggressively during this last mile.”

The latest economic reports offer grounds for wariness. A key gauge of euro-zone pay that policymakers had hoped would show inflation had finally been conquered failed to moderate — indicating price pressures, particularly in the services sector, may take longer to ease. Indeed, inflation picked up to 2.6% last month from 2.4% in April — more than expected.

At the same time, the 20-nation economy bounced back more resoundingly than anticipated after the mild recession it suffered in the latter half of last year, with the labor market staying resilient, unemployment recently hitting an all-time low and business surveys even showing signs of life at struggling manufacturers.

No one sees policymakers reneging on June’s cut, which will trim the deposit rate from the record 4% it reached nine months ago. And the overall retreat in consumer-price gains should resume in the coming months.

Still, economists expect fewer moves this year. Almost half of respondents in a Bloomberg survey before the ECB’s April meeting anticipated four or five rate reductions in 2024. Nobody predicts five anymore, and the share that sees four has declined.

Story continues

Similarly, markets — having priced three reductions for this year as recently as April — have now ruled out July and only put the chances of a September step at 60%.

“We believe the ECB will revise their quarterly inflation projections higher, creating an awkward backdrop for the cut,” Gabriele Foa, a portfolio manager at Algebris Investments, said in an emailed note. “Markets have almost fully ruled out a July cut, and now only see around two cuts in total by year-end. As things stand, we believe an ECB cut this week may soon be viewed as a policy mistake.”

Danske Bank’s Piet Christiansen and Mariano Valderrama, an economist at Intermoney in Madrid, are among those that don’t envisage a second decrease until as late as December, according to a recent Bloomberg survey.

“We have doubts regarding September,” said Valderrama, citing the jobs market, wages and speedier economic expansion. What’s more, “fiscal policy isn’t going to become much less restrictive this year.”

Others, like Gebhard Stadler at Bayerische Landesbank, predict a pause in the final month of the year, after just two reductions.

“Core inflation will prove to be more stubborn than the ECB has estimated so far given continued, strong wage growth and healthy margin trends,” he said. “In addition, there’s great uncertainty due to the US elections — also with regard to trade policy and the euro-dollar exchange rate.”

The Fed has signaled that US rates may have to stay high for longer to ensure inflation returns to 2% — raising questions over how far ahead the ECB can venture on its own. ECB President Christine Lagarde and her colleagues, while starting sooner, emphasize that they’re in no rush to lower borrowing costs.

Chief Economist Philip Lane has said policy will remain restrictive throughout 2024, pledging to take his cue from the data as they arrive. And despite insisting on a meeting-by-meeting approach, some fellow officials have provided some rather hawkish pointers.

For Schnabel, concerns about premature policy easing argue against a second decrease in July, while Nagel said that “if” the ECB delivers in June, it will “have to wait till maybe September” to do so again. Holzmann stressed that just because he’s “ready to support one cut,” he won’t back others if they’re not justified.

“In the past, a first rate cut was always followed by further rate cuts to support growth and/or to response to a crisis.” said Carsten Brzeski, ING’s head of macro. “This time around, however, there’s none of these two. Therefore, there’s a high risk that the ECB could be forced to move from ‘one is none’ to a ‘one-and-done’ stance.”

–With assistance from Alice Gledhill, Harumi Ichikura and Libby Cherry.

(Updates with economist forecasts in ninth paragraph.)

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