Reducing Rates: What's Next? Five Inquiries for the ECB

Boston Brand Media brings you the latest - Delving into the aftermath of rate reductions, this header poses five crucial questions regarding the European Central Bank's future decisions and actions.

June 3 (Reuters) - The European Central Bank (ECB) appears poised to decrease rates this Thursday, marking the first reduction since 2019. However, the subsequent course of action remains uncertain. Inflation has approached the bank's 2% objective, surpassing expectations in May, particularly in the services sector, where it continues to persist. 

Boston Brand Media also found that the region's economic rebound outpaces forecasts, and the labor market remains tight, raising questions about the frequency of rate cuts the ECB might undertake this year.

"The actual rate reduction won't cause a stir. The real focus lies in the communication strategy regarding future actions," stated Jens Eisenschmidt, former ECB member and current Chief Europe Economist at Morgan Stanley. Here are five pivotal inquiries for markets:

1.Is the ECB poised to implement interest rate cuts this week? It's highly probable, considering the numerous policymakers essentially guaranteeing a rate decrease in June. Anticipations lean towards a 25 basis-point reduction, lowering the ECB's deposit rate to 3.75% from its record peak of 4% set in September.

How will the trajectory of rates unfold post-June? This remains considerably ambiguous. Presently, markets anticipate fewer than 60 basis points of reductions for the year, indicating two adjustments with less than a 50% probability of a third, contrasting the three anticipated during the ECB's previous April meeting and at least five projected in January. Despite this, numerous analysts still predict three cuts, slated for June, September, and December, coinciding with the ECB's release of updated economic projections during these meetings.

Some policymakers, known as hawks, aim to eliminate the possibility of a July adjustment. Conversely, individuals like French central bank governor Francois Villeroy de Galhau are hesitant to completely rule it out. Hence, don't anticipate comprehensive guidance from ECB head Christine Lagarde this Thursday. Analysts predict she will reiterate the ECB's stance of being "data dependent." "I anticipate they will refrain from providing specific directives for the future, unlike what we saw during the June meeting," stated Paul Hollingsworth, Chief Europe Economist at BNP Paribas.

3. How concerning is the uptick in wage growth for the ECB? According to economists, it's not a major worry. Prior to considering rate reductions, policymakers sought further evidence of decelerating wage growth. However, May's data revealed an increase to 4.69% in the first quarter, albeit influenced by a substantial figure from Germany, where wage growth is still aligning with inflation. The ECB appeared unfazed, indicating through a blog post on the same day that alternative wage metrics suggest easing pressures. Even Joachim Nagel of Germany, a prominent hawk, downplayed the significance of the data. However, service sector inflation, indicative of domestic demand, saw a resurgence in May, while historically low unemployment levels also raise doubts about potential wage moderation. The wage statistics "highlight the need for a gradual approach in the rate reduction cycle, as further confirmation is awaited to ensure reaching the 2% inflation target in due course," remarked Jens Eisenschmidt of Morgan Stanley.

4.How does the strengthening euro zone economy factor in? It's not a source of worry either. The region's economy expanded by 0.3% in the first quarter, surpassing the anticipated 0.2%. Forward-looking business activity indicators also exceed predictions, signaling sustained recovery. Economists view these figures favorably for the ECB. Increased activity could alleviate concerns about sluggish productivity growth, partly attributed to labor retention, thus bolstering confidence in curbing inflation. Moreover, the growth rates aren't high enough to trigger apprehensions about rekindling inflationary pressures. "The recent economic indicators are promising. They counter arguments from the most vociferous doves, suggesting economic distress necessitating swift rate cuts," remarked Reinhard Cluse, UBS's Chief European Economist.

5.What are the expectations for the ECB's upcoming projections? The ECB is anticipated to make slight upward revisions to its growth and inflation forecasts. However, this is unlikely to alter its anticipation that inflation will align with the target by late 2025. "The overarching outlook should mirror that of March," stated Konstantin Veit, Portfolio Manager at PIMCO.

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Source: Reuters‍