ECB Insight: Insiders Convinced of 25BP Cut in December, Tilting Towards Another in January

14 November 2024

By David Barwick and Marta Vilar – FRANKFURT (Econostream) – In the following we share views gleaned from numerous recent exchanges with European Central Bank Governing Council members regarding the current monetary policy outlook. We depart from our usual format and make key points in list form for the sake of conciseness:

1) A 50bp cut in December is very unlikely. This is not new in general, and even less new for us, as we’ve argued against this scenario ever since the day after the last ECB press conference. What is a bit new is that the doves on the Governing Council have reluctantly come to realise that their chances of getting an outsized move are slim to none. One called the prospects for 50bp ‘difficult’, and we think that was even a bit optimistic. Of course, there are still plenty of data between now and 12 December, as policymakers expressly noted.

2) A 25bp cut in December is very likely. This, too, will come as no surprise. Yet we are struck by how much acceptance for this we see among the same hawks who firmly oppose 50bp. Acceptance not in the sense of resignation, but rather the expectation that another 25bp cut (but no more) will be absolutely appropriate. One called such a step ‘reasonable’ if developments went according to plan, while two said that their central scenario was that the new projections would justify an earlier return to neutral and thus another 25bp of easing at the next opportunity. That said, various hawks also floated the idea that, in the words of one, if October’s cut ‘turned out to be too early’ when the updated projections became available, then ‘you could also do nothing in December.’ That person even said that the possibility of not cutting in December had led him to agree with the October cut. Still, it was clear that – from today’s perspective - the doves are only likely to encounter resistance if they want a cut of more than 25bp. As one centrist governor said, ‘I can’t find any reasonable argument for not doing 25bp in December.’

3) Another 25bp cut in January seems somewhat likely. Further out, everything becomes less clear, and policymakers, to the extent they wish to speculate, are correspondingly less certain. Nevertheless, one called it ‘possible’ that multiple back-to-back cuts would follow December’s, while another echoed that thought, subject to 2% inflation being reached around the end of 1Q. Another appeared to assume that the ECB would cut by 25bp at every meeting up to and including the one in June (which for him was also a reason why ‘you don’t need to do 50’ basis point cuts). A fourth, particularly hawkish governor considered cuts in December and March essentially givens, with the bar for a January cut ‘slightly higher’, but reachable if disinflation continued. Indeed, this person said he was leaning towards cutting at every meeting, a shift from his earlier preference for moving only in conjunction with updated projections. Inflation was declining more rapidly, with wages following, so ‘we could also go a little bit quicker’, he argued.

4) On average, HICP of 2% is seen reached in 2Q. Opinions were divided on this question, with high uncertainty evident on the part of all but one governor we spoke to, but 2Q seemed the median expectation. One person, citing economic weakness and recent inflation data, supposed that 2% would be reached ‘a quarter or two sooner’ than in the September projections, which envisioned price stability achieved in 4Q 2025. Another agreed that the date of reaching 2% would move closer, without speculating by how much, though he allowed that 1Q would be ‘awfully early’, given how soon that was from today’s perspective. The idea that 1Q might prove too soon was also expressed by a less hawkish colleague. In contrast, a particularly dovish governor predicted a timing of 1Q with great confidence, while someone towards the opposite end of the spectrum said that market expectations regarding how soon 2% would be reached ‘might be a little bit too much’ and that 2Q was well possible, with neither 1Q nor 3Q excluded. Any date projected now could be upended by policies of US President-elect Donald Trump once he assumed office, this person reminded.

5) Economic recovery is still expected. Ironically, it was a dove who sounded most upbeat, affirming that the economy had been weak until flash GDP data had emerged at the end of October to contradict the perception of weakness. Indeed, it was precisely because ‘now the economy is much stronger’ than believed that this person ruled out 50bp in December. This person was hesitant to agree that the next macroeconomic projections would include a downgrade of the growth outlook, though he underscored the new uncertainties related to the US and Germany. Everyone else was sober about prospects for growth, but clung to the idea that the recovery was coming. One repeated the idea that activity was firmer than thought in October, but said it was nonetheless no ‘new dawn’ yet for the euro area economy. Another person argued that ‘all conditions’ were met for a gradual pickup of domestic demand. Labour market strength was cited repeatedly.

6) ECB President Christine Lagarde sounded too dovish in October. Having expected Lagarde to balance the cut with more hawkish language at the last press conference, we admit to being gratified to find that some Council members also feel that Lagarde would have ideally struck a less dovish tone. One person - who in this context urged policymakers not to ‘be too downbeat and only talk about weakness’ - said that while Lagarde had ‘said all the right things’ at the press conference, ‘she could have perhaps also said some other things.’ In effect, she ‘missed that opportunity’ to offer a ‘balanced message’, he said. Another governor drew attention to the fact that the monetary policy statement had not characterised risks to inflation as tilted in one direction or the other, but rather merely enumerated them in a manner suggesting balance, whereas Lagarde during the press conference asserted that there was ‘probably more downside risk than upside risk’ to inflation. Yet another governor agreed that Lagarde could have been more hawkish, but defended her by saying that ‘you cannot always do 100%.’ Another said it was ‘impossible’ for Lagarde to manage a balance that would ‘pre-empt’ the ‘campaign’ mounted by doves to accelerate the pace of easing.

7) Key language could change in December, but January or even later can’t be excluded. Here we are thinking of the vow to ‘keep policy rates sufficiently restrictive for as long as necessary’. Policymakers were very much up in the air about when the removal or modification of this phrase would be warranted. One governor said December was possible but not inevitable, with the timing data-dependent. Another predicted ‘different views’ and that there would be a discussion of this ‘in a couple of meetings’ time’, suggesting in effect that December might be soon. Another however was very clear that this wording should ‘go away’ and predicted that ‘December is the last month that we are going to see that.’ Another governor said that even with the likely 25bp cut in December, there would be no ‘urgent need’ for removing the wording, since 3% interest rates remained restrictive and markets could interpret the removal as ‘a signal that we will speed up’, a constraint the ECB should avoid. Yet another governor suggested that the wording could be ‘weakened’ to ‘appropriately restrictive’ or something similar. In any event, this person reasoned, any level of rates above neutral being restrictive, ‘it doesn't hurt to use the word’. The decision was largely Chief Economist Philip Lane’s to make, he said, since it depended on the updated projections that Lane was responsible for.

8) The ECB will stick to its data-dependent, meeting-by-meeting approach. Would that all questions were so readily answered. No one we spoke to was even flirting with thoughts of abandoning the ECB’s current approach.

9) The neutral rate is generally seen at 2% to 2.5%. One particularly dovish governor thought the nominal neutral rate could be as low as 1.7%, but others tended towards a tighter range between 2% and 2.5%. One person suggested 2% or 2.25% and regarded estimates of 1.75% as very dubious and of 2.5% as somewhat questionable. Whether 2% or 2.25% was correct ‘nobody would even bother to discuss’, as it made little difference and could not be determined reliably anyway, he said. One relatively hawkish governor said he was ‘exactly’ aligned with most of his colleagues in seeing the neutral rate at between 2.25% and 2.5%. Another governor saw the real neutral rate at ‘around zero’, with the sign uncertain.

10) The updated projections could show HICP of under 2%. To be clear, no one wanted to go out on a limb and voice the specific expectation that 2027 HICP would be under 2%. Rather, amid great uncertainty as to the outcome of the projection exercise, policymakers did not exclude the possibility. One governor said he was ‘really curious’ about the 2027 forecast, which could be ‘close to 2%’, or, on the other hand, ‘something that gets us down to 1.5%.’ Another expressed concern that the 2027 projection could be below 2% and lead to unwarranted claims by doves that the ECB was undershooting and to demands to react. Similarly, another warned that if 2027 HICP were estimated at 1.7% or 1.8%, it would still not justify discussing a 50bp cut in December.