ECB Insight: No Signals, No Flags, No Guidance, No Promises

16 July 2024

By David Barwick – FRANKFURT (Econostream) – It is a struggle to come up with much about the European Central Bank Governing Council’s current policy stance that monetary authorities are likely to want to change this week. The key interest rates should figure near the bottom of any list.

True, prospects for growth have softened somewhat of late, and the ECB will acknowledge this. In contrast, the most recent evolution of inflation, if still within the limits of what policymakers can claim to have expected, does not warrant additional loosening of the monetary reins so soon in an environment of uncertainty.

That is all the more so given the Governing Council agreed to the June cut, to be frank, on a wing and a prayer. From our perspective, it remains yet to be seen whether that bet will pay out.

Even if it does, we think Council members recognise that it can be debated whether this owes more to fortuitous coincidence or to their foresight in choosing precisely the month of June to start easing.

So it is that with the latest data mixed and uncertainty still elevated, and lacking the guideposts of fresh macroeconomic projections, what the ECB at the current juncture most needs to do is simply kill time.

That makes its data-driven, meeting-by-meeting approach singularly convenient, and we expect ECB President Christine Lagarde to rely on it to ward off all attempts to divine the path interest rates are likely to follow.

Not only may she decline to give explicit encouragement to all but very general hopes of more easing – for example, we suspect she will still show reluctance to, as she put it last time, ‘volunteer’ that the ECB has entered the so-called dialling-back phase – but in particular, she is unlikely to flag any intention of a second step in September.

Why should she? Avoiding such signals worked perfectly well in June, and offering guidance would be inconsistent with the ECB’s current approach to policy as well as the uncertain atmosphere in which, just to name one possibility, high euro area government spending could yet breath new life into inflation.

Moreover, it is apparent that opinions on the wisdom of a September cut already diverge among policymakers, whose views even in June were more nuanced than the headline outcome appeared to suggest.

Even doves on the Council - see Banco de Portugal Governor Mário Centeno or Banca d’Italia Governor Fabio Panetta - seem at least resigned to, arguably even comfortable with the idea that euro area borrowing costs are going to descend only gradually.

For now, this already takes non-projection meetings off the table for rate moves, absent truly compelling interim data, and also suggests a recognition that even with respect to projection meetings, the easing process may not proceed uninterrupted.

As if that weren’t enough, nobody on the Council is complaining about market expectations, which do not currently put overwhelming pressure on the ECB to cut again in September, let alone to declare in July an intention to do so.

Finally, we hark back to the idea that the 6 June cut was the product of a volley of communication such that, even when the June timing had come to appear less propitious, the ECB was left with little choice but to grit its teeth and cut.

Numerous Council members have left no doubt in speaking to Econostream that they see the ECB as having made what some branded a mistake in preaching data-dependence while relentlessly flagging June.

This perception seems likely to influence communication for a while, perhaps even longer if the choice of June turns out to have been unfortunate not just in real time six weeks ago, but in hindsight as well. This suggests that a high degree of reticence about the possible path of interest rates will remain the order of the day.

And will the ECB cut in September? On balance we think it will, provided there is no substantial worsening of the inflation outlook versus the current macroeconomic projections.

Our reasoning follows that expressed by some Council members in explaining to Econostream their support for the June rate cut.

According to that logic, in the absence of an important reason to doubt the projections – the reliability of which policymakers have been lauding for months – then given the current unambiguously restrictive level of interest rates, a certain amount of easing has to be accomplished by end-2025. If the ECB, inclined to small steps, doesn’t want to fall behind the curve, that indicates small rate cuts on a somewhat regular basis.

The potential volatility of spot inflation data does not change this, provided the inflation ‘bumpiness’ does not reflect developments that have negative implications for medium-term price stability.

This latter idea seems to be accepted fairly widely, and indeed found mention in the account of the June Governing Council meeting, to wit: ‘It was important to recognise that a smooth, linear disinflation process in 2024 was not a prerequisite for confidence in a timely return of inflation to the target.’

The apparent weakening of economic developments would tend to reinforce our expectation of a September cut.

However, this is not a necessary element, and even without it, we would consider the rationale for a September cut given if the ECB continues to have faith in the disinflation process, anchored by the medium-term outlook.