ECB Insight: Council to Discuss 50BP but Unite Behind 25BP; Change of Language Possible but No Given

10 December 2024

By David Barwick – FRANKFURT (Econostream) – At Econostream we’ve been nothing if not consistent for almost seven weeks about playing down expectations that the European Central Bank Governing Council would cut by 50bp in December. Already on 18 October we contended that markets were indulging in wishful thinking.

Now that nearly everyone is on the same page, we haven’t had a change of heart. The message of public commentary and background interactions with numerous policymakers has simply been too clear for us to seriously envision anything but a 25bp cut on Thursday.

Nonetheless, we don’t completely rule out other possibilities, the likelier of the two conceivable alternatives obviously being a 50bp cut (the less likely being nothing at all).

That we don’t fully exclude a surprise is not because we think the ECB all along intended something else and has been enjoying an elaborate hoax at the expense of media, financial markets and the general public, or even because we think French political turmoil will change minds at the last minute.

Rather, we can’t be absolutely certain that the updated projections won’t justify a surprise.

That said, nothing we’ve seen or heard suggests that a surprise based on the new forecasts is more than a tail risk, or that policymakers themselves don’t also see it this way.

Given which, the evidence for 25bp and against 50bp speaks for itself. A small sample could include:

• Bundesbank President Joachim Nagel on 4 December said he ‘would have no objections if we were to continue to reduce our policy rates’ but would ‘caution against lowering the degree of restriction too hastily’, as ‘rates should converge slowly and at a measured pace towards neutral territory.’
• Central Bank of Luxembourg Gaston Reinesch on 4 December called it ‘reasonable to expect another 25bp cut next week’.
• Bank of Greece Governor Yannis Stournaras on 29 November called a 25bp cut ‘the most likely scenario’.
• Central Bank of Ireland Governor Gabriel Makhlouf on 4 December said that he ‘would need to see some pretty significant evidence to push me into making a big leap, more than 25bp.’
• Austrian National Bank Governor Robert Holzmann said on 3 December that ‘the probability isn’t zero that there will be another rate cut — but it will be moderate, not very strong, the data so far don’t point toward that.’
• Central Bank of Cyprus Governor Christodoulos Patsalides on 18 November saw ‘room to continue lowering rates at a steady pace and magnitude’.

The case for 25bp is clear enough to anticipate unanimous support – following discussion of a larger move - and make speculation about other aspects of Thursday’s outcome a more interesting topic.

One question on which we remain up in the air is whether key language (‘sufficiently restrictive’) will change. It could, but it doesn’t have to. If it does, the change should be small (‘marginally if at all’, as one governor told us). Any change would of course be dovish.

A plurality of governors argued vis-à-vis Econostream that rates are and will remain restrictive for a while, making the current language still factually correct and thus appropriate.

What could a small change look like? It’s hard to guess, but another governor suggested off the top of his head ‘appropriately restrictive’ instead of ‘sufficiently restrictive’. We could more easily envisage ditching ‘sufficiently restrictive’ altogether in favour of something like ‘at an appropriate level’.

The decision is mainly Chief Economist Philip Lane’s to make, and he has said that at some point this will have to change, but that there is no timetable. Still, the protestations of Banca d’Italia Governor Fabio Panetta that the current wording implies a tightening bias may fall on fertile ground this week.

We keep in mind what one hawkish governor told us about a change of phrasing, namely that ‘if we did it as a concession or something, I would not be opposed to something like that.’ Given universal agreement about the direction of rates, resisting new language is a hill no one will want to die on.

Another aspect is ECB President Christine Lagarde’s likely tone. In October we expected it to be ‘slightly hawkish’ to offset the cut, yet she erred on the side of dovishness. As it turned out, some Council members told us that she had been unnecessarily bleak; two accused her of misrepresenting risks to inflation by saying at the press conference that these were mostly to the downside.

As there may be more reasons for her to err dovishly now than in October, and a modification of the statement could make for a new dovish impulse, we see a higher risk of dovishness than of any other ‘tilt’ by her.

But assuming (as we do) that the ECB will stick to its data-dependent, meeting-by-meeting approach, then in any case we expect her to refrain from dropping hints about the next move, other than perhaps to confirm for the umpteenth time that the direction of interest rates is down.

As to the next move, we tend to think that the current situation offers lessons for January and even beyond, abstracting from major changes in the policy environment.

The key point is that the hawks, who seem to be aligned with most moderates, are comfortable with 25bp cuts at consecutive meetings and uncomfortable with 50bp cuts.

Whether it’s because 50bp would suggest unnecessary panic; make no sense because the ECB is not behind the curve (even Banque de France Governor François Villeroy de Galhau said on 22 November that the ECB was not behind the curve); ignore any of the reasons Executive Board member Isabel Schnabel gave on 25 November to move gradually; or simply violate preferences for a steady, stable approach, something would have to happen for these arguments not to apply end-January.

Absent any exceptional development, meaning if the baseline continues to more or less materialise, then we can see a measured, gradual approach to easing remaining the rule. Meanwhile, the steady approach of neutral rates will only make adjusting the stance in leaps and bounds less appealing.

To be sure, the prerequisite of nothing happening is subject to greater question at a more distant horizon. Still, taking the current situation as a blueprint could easily be valid in January, as some Council members will want to see inflation forecasts that reflect service sector agreements reached early in the year, which won’t be possible until the March projection exercise, and others may feel that there will be insufficient clarity about wage growth until mid-2025.

Germany’s Institute of Economic and Social Research last Friday predicted a nominal 5.5% increase next year for collective wages in the euro area’s largest economy, underscoring that the issue of wage developments has the potential to remain topical for monetary policy.

Some might say that on 30 January, US President-elect Donald Trump’s tariff intentions will finally be clear, but policymakers seem divided about the ramifications. The effects ‘can play in two directions’, as one governor told us, and uncertainty makes it tough to incorporate them in the ECB’s baseline.

All in all, from today’s perspective, we see the path to the terminal rate as paved with 25bp cuts at every meeting unless an unexpected development compels acceleration.