ECB Set to Cut Rates Despite Inflation Uptick

Even
if
the
ECB
cuts
rates
on
Thursday,
investors
assume
that
the
central
bank
will
proceed
at
a
very
slow
pace
in
lower
borrowing
costs
and
reversing
a
number
of
rate
hikes
in
recent
years.

In
total,
markets
currently
price
in
less
than
0.60%
in
cuts
in
2024,
meaning
two
moves
and
a
50%
chance
of
a
third.
This
is
down
from
April,
when
markets
anticipated
three
rate
cuts,
and
from
January,
when
at
least
five
cuts
were
on
the
table,
according
to
Reuters.  

The
cut
on
June
6
seems
a
done
deal
but
any
other
outcome
will
shock
the
markets
on
Thursday,
says Michael
Field,
European
market
strategist
at
Morningstar.   

Eurozone
Inflation
Ticks
Up

The
anticipated
cut
comes
despite
the
recent
flare-up
in
eurozone
consumer
prices.
Inflation
had
neared
the
bank’s
2%
target,
but
both
headline
and
core
inflation
numbers
for
May came
in
above
expectations,
marking
the
first
month-on-month
acceleration
of
2024.  

Eurozone
inflation
rose
to
2.6%
year
on
year,
from
2.4%
in
April, Eurostat
said
on
May
31.
Core
inflation,
which
shows
prices
without
energy
and
food
costs,
also
accelerated
to
2.9%,
from
2.7%
in
April. 

Will
the
ECB Cut Rates Again
in
July?

Thursday’s
ECB
rate
announcement will
be
closely
watched
for any
signs
of
what
happens
beyond
June.
Markets will
seek
guidance
from
the
ECB’s
president
Christine
Lagarde
on
any
potential
cuts
at
its
July
18
meeting.  

“Inflation
in
the
Eurozone
has
fallen
markedly
over
the
last
18
months
or
so,
which
has
taken
the
pressure
off
the
ECB”,
says
Field.

“That
said,
the
labour
market
in
Europe
remains
tight,
with
the
lowest
unemployment
rate
in
more
than
30
years.
Services
inflation
is
proving
stubborn,
and
while
general
inflation
is
running
only
60
basis
points
above
the
ECB’s
targeted
2%
level,
it
is
understandable
that
the
bank
does
not
want
to
rush
into
mass
rate
cuts
and
potentially have
to reverse
course
if
inflation
rises
much
further.

“Whether
more
rate
cuts
follow
this
year,
or
early
next
year,
will
likely
not
move
the
needle
either
way.
The
ECB
has
indicated
its
desire
to
reduce
rates,
so
while
the
timing
of
rate
cuts
is
not
yet
100%
clear,
the
direction
of
travel
is
at
least.”  

Konstantin
Veit,
portfolio
manager
at Pimco,
doubts
the
ECB
to
give
much
guidance
on
Thursday,
and
expects that the
council
to
reaffirm
its
meeting-by-meeting
approach
and rely
on
the
data.

“We
therefore
believe
it
is
unlikely
that
the
ECB
will
commit
to
a
specific
interest
rate
path”,
he
says.
However, Pimco expects
a
cautious
approach,
with
0.25
percentage
point
moves.

Marco
Wagner
of
Commerzbank
Economic
Research
said
in
a
May
31
note:
“There
is
certainly
a
risk
that
the
numerically
superior
doves
in
the
ECB
Governing
Council
will
seize
the
opportunity
and
push
for
a
second
interest
rate
cut
in
July.
If
the
inflation
figures
in
May
and
June
turn
out
to
be
low,
this
would
not
be
out
of
the
question.

Monetary
Policy
to
Remain
Restrictive

“The
doves
could
argue
that,
despite
a
first
rate
cut
in
June,
real
interest
rates
are
unlikely
to
fall
in
view
of
the
downward
trend
in
inflation
and
that
monetary
policy
will
therefore
remain
restrictive.
However,
some
governing
council
members,
such
as
Estonian
Madis
Müller,
have
now
explicitly
spoken
out
against
a
rapid
further
rate
cut
in
July,”
Wagner
added.

“Other
members
…
such
as
Spain’s
Pablo
Hernández
de
Cos
…
have
spoken
of
proceeding
with
caution
after
the
June
move.
We
therefore
still
do
not
expect
a
rate
cut
in
July.”

According
to
economists
at
Swiss
bank
J.
Safra
Sarasin:
“As
the
market
prices
in
a
slow
pace
of
about
1.5
in
cuts
for
the
rest
of
the
year.
This
is
not
much,
in
our
view.
Inflation
is
trending down and
economic
growth
remains
sluggish
following
two
years
of
stagnation.
Policy
is
clearly restrictive and
the
ECB
can
afford
to
be
a
bit
bolder.”

They
continue
to
expect
the
cut
to
be
followed
by
three
more
this
year. 
“This
is
not
much,
in
our
view.
Inflation
is
trending down and
economic
growth
remains
sluggish
following
two
years
of
stagnation.
Policy
is
clearly restrictive and
the
ECB
can
afford
to
be
a
bit
bolder”,
reads
a
May
29
note
by
the
analysts.  

How
Will
Interest
Rate
Cuts
Affect
Markets? 

Equity
markets
tend
to
rise
on
anticipated
rate
cuts,
while
bond
markets
tend
to
suffer.
On
the
other
hand,
with
interest
rates
already
high,
falling
interest
rates
also
mean
lower
bond
yields,
which
pushes
bond
prices
higher.
Lower
rates
also
make
existing
bonds,
and
particularly
those
already
issued
during
a
period
of
high
rates,
more
attractive
for
yields. 

Meanwhile
cash
savings
rates
on
bank
accounts
will
likely
decrease,
to
the
detriment
of
savers.
Borrowers,
by
contrast,
stand
to
benefit
from
lower
rates
as
consumer
debt
and
mortgages
become cheaper.
In
its
latest
Economic
Bulletin,
the
ECB
said that
borrowing
rates
remain
elevated,
with
a
further
slight
tightening
for
lending
to
firms
and
a
moderate
easing
for
mortgages. 

What
Will
Markets
do
if
the
ECB
Holds
Rates? 

Conversely,
if
the
ECB
surprises
markets
and
does
not
cut
rates
on
Thursday,
both
equity and
bond
prices
will
fall,
my
colleague
Sara
Silano reports. “Monetary
policy
that
is
tighter
than
expected
usually
has
a
negative
impact
on
bond
prices,”
says Nicolò
Bragazza,
associate
portfolio
manager
at
Morningstar
Investment
Management. 

“Government
bonds
with
longer
duration
are
the
most
affected
as
they
are
more
sensitive
to
tighter
monetary
policy
expectations.” 

On
the
equity
markets,
the
sectors
most
affected would
be
utilities,
real
estate
and
consumer
discretionary
goods. 

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