ECB Insight: Latest HICP Data Continue to Leave September Rate Decision Open

31 July 2024

By David Barwick – FRANKFURT (Econostream) – Some observers of the European Central Bank have reacted to the July euro area inflation data released Wednesday by reflexively inferring that they materially reduce the chances of a September rate cut. We feel a shrug would be the more appropriate reaction.

The ECB itself has made a downright mantra out of the fact that it is data-dependent but not ‘data-point-dependent’. In other words, nothing rises or falls based on one lonely little data release.

That the ECB is intent on hammering home the point that the Governing Council, unlike some market participants, does not react reflexively to any single piece of information doubtless reflects a desire to dissuade markets from assuming that the outcome of a decision has become a foregone conclusion (or the final one in a series of foregone conclusions that vacillate yoyo-like with the ebb and flow of daily news).

For example, the ECB would prefer to ward off conclusions like that drawn promptly by one major private bank’s analysts after the release of July HICP, namely that ‘today's figures make a September rate cut from the ECB a very close call’.

Why would forestalling this be an ECB objective? The answer is that the ECB wants to retain the freedom to move in a direction at odds with a given data point, even an important one (which is not what we claim today’s was).

Indeed, we think the ECB does not want to feel it cannot act contrarily to the ostensible message of even a series of data points that may appear to point in a policy direction other than the one chosen.

At the current moment, given the bias of monetary policy in the direction of lower rates, and the well-known ambiguity of incoming information, this is logically not in order for the ECB to be able to hike – or even just to do nothing - when some new information, seen in isolation, argues instead for easing.

Rather, the idea is more likely to be that even when the data have been of a dubious nature, this should not necessarily paralyse policymakers. That is, they can ease even when the merits of easing don’t rise to the level of a ‘no-brainer’.

That’s one point. Of course, we could also argue that most releases are not monolithically positive or negative. That would certainly also be the case for July euro area HICP, which included a slight reduction in services inflation, the first in some months.

That gets us gradually to a larger point, namely that the headline figure of a release may lend itself to headlines but will hardly ever determine monetary policy.

At most, in the words of Executive Board member Isabel Schnabel in her interview Monday, ‘a monthly inflation rate may well be informative, because it may indicate that we need to review the assumptions underlying our projections.’

These quarterly projections, of which even all the constituent numbers of one inflation release are still only a fraction of the many, many components, are where we think the validity of the ECB’s rejection of ‘data-point-dependence’ may come to an end. This is why Schnabel treats the projections as the reference frame to which single data points are subordinate.

We have posited – and continue to believe - that the ECB is likely to cut rates again in September, provided that the price stability outlook, expressed by the projections, does not significantly worsen versus June.

With all due respect to sophisticated models updated with each new bit of information in real time, we think the ECB will reserve judgment for the remaining six weeks until it has the new projections in hand. And perhaps excepting the most hawkish Governing Council members, we don’t think that today’s inflation data reflexively induce an increased unwillingness to cut rates on 12 September.

Perhaps a better way of putting this is to say that we think that the ECB needs to be convinced not to cut. That is, if developments - to be distilled into the updated projections - either argue clearly for more easing or simply move sideways between now and the September meeting, then the default decision will be to take another step down.

That said, the odds are not overwhelming. In the sideways case, such a decision is highly unlikely to be unanimous, with Austrian National Bank Governor Robert Holzmann probably not the only one ready to object.

But our baseline for a September outcome of no cut is not the sideways case, but rather a new set of projections in which 2% inflation is seen receding to a more distant horizon than in June.

If this condition is met, the risk that the ECB will still cut is limited. Limited but not complete, because even in such a case, the ECB could still ease, if - despite 2% being reached later than currently envisaged - inflation thereafter were projected to decline more sharply than presently expected.

In the end, it remains too early for as high a degree of certainty as implied by the analyst quoted at the outset who, on the basis of today’s data, deemed a September rate cut a ‘very close call’.

ECB President Christine Lagarde on 18 July said that euro area would ‘fluctuate around current levels for the rest of the year’ and then ‘decline towards our target over the second half of next year’.

We don’t see the rise in headline HICP from 2.5% in June to 2.6% in July as so inconsistent with this as to be the basis for any conclusion about the 12 September Governing Council decision. For now, we are therefore limiting our reaction to a shrug.