Exclusive: ECB’s Wunsch: A Second Cut in July Would Lead to Repricing That Might Go Too Far

29 April 2024

By David Barwick – WASHINGTON (Econostream) – Were the European Central Bank to cut interest rates in both June and July, financial markets would tend to anticipate a relatively fast pace of further monetary policy easing, potentially leading to another bout of unjustified exuberance, according to ECB Governing Council member Pierre Wunsch.

In an interview (transcript here) with Econostream on April 20, Wunsch, who heads the Belgian National Bank, warned that not all the ECB’s ducks were lined up yet. This, like the suddenly different outlook in the US, argued for a cautious approach in Europe to reducing official borrowing costs, he said.

Moreover, the economic improvement the euro area would likely experience this year could ultimately support continued elevated wage growth, he observed.

The ECB was ‘a bit below the path that was forecast three to six months ago, and that gives some level of comfort’, he said. ‘At the same time, some of the components are still not where they need to be. And that argues for caution.’

It was not only the situation here that called for prudence, he said: ‘[W]hen you see how fast the mood has changed in the US, that's also a reason for caution.’

Furthermore, Wunsch reasoned, the expected pickup in euro area growth could render already tight labour markets yet tighter, conferring more bargaining power on workers and making it ‘very possible’ that rather than moderate their wage demands, the latter would demand another two years of high increases.

This however would not become apparent ‘for a long time’, he said. Nonetheless, the ECB could, barring nasty surprises, ease to 3.5%, a level he said was still cautious, but monetary authorities would in effect need to dole the easing out.

‘You don't want to do it in one meeting’, he said. ‘But even cutting again in July would be interpreted by markets to mean that we’re going to cut every meeting. And that would lead to repricing that might go too far.’

Still, he emphasised, this was a call for caution not meant to exclude anything that incoming data might warrant.

‘My base case is at least two cuts in 2024’, he said. ‘But if we only do two or even three cuts, then we shouldn’t communicate that we're going to cut at every meeting.’

The ECB could not rely on rhetoric to convey this message, he suggested.

‘We've seen markets getting carried away in the past based on not so much news’, he said. ‘There have been huge swings on various occasions even recently. So, we need to keep calm and collected and not contribute to very significant swings in the market.’

Once the ECB had cut to 3.5%, further steps would require ‘data confirming that inflation is going to continue to go down’, he said. With core inflation at 3%, though, ‘we still need to be restrictive for some time’, he said.

Fiscal policy in euro area member states was not a great problem in the short run, but ‘over the medium term I'm concerned’, he said. ‘It's an accident waiting to happen.’

The situation in this respect was aggravated by the difficulty in some countries of forming a government, he said. When the process involved many different parties, the outcome was usually loose fiscal policy, he said.

‘And it's just not sustainable’, he said. ‘When it's not sustainable, at some point we will hit a wall if a correction does not take place.’

In other comments, Wunsch expressed uncertainty about the usefulness of introducing a Federal Reserve-style dot plot for the ECB. Although such a tool would serve to highlight the gamut of views on the Governing Council, it wasn’t clear that it was worth it, he indicated.

‘There is always a concern that people will try to identify who's behind the dots, and that there will be political pressure here and there when individual positions get reported’, he said.

A further reason for scepticism had to do with the disparate sizes of euro area national central banks, he said.

‘I would be a bit concerned that with respect to the smaller ones that lack the modelling capacity for Europe, there would be a sort of traction towards the market forwards for lack of anything else’, he explained. ‘And then you pretend that you're not based on market forwards, but maybe a lot of governors, for lack of alternatives, would just reproduce or be close to what the market is producing.’