ECB Preview: Will EUR pay heed to the pushback to April cut expectations?

ECB likely to push more firmly against aggressive easing expectations

The European Central Bank will announce its next policy decision on January 25 and no change is expected to policy rates. However, the discrepancy in the Bank’s expectation of the rate curve and that of the market remains a key debate. Market is currently pricing in over 65% odds of a rate cut in April and 43bps of easing by June. In contrast, ECB officials have presented a rather united front in pushing back against these expectations with President Lagarde sending a strong signal last week at the Davos meetings where she said that cuts are likely only to begin by summer. That would mean June or July, with Lagarde saying that information needed to assess the strength of wage pressures would only be fully available by “late spring”.

Broad rhetoric is unlikely to be any different, but the bigger question is whether it makes sense and if the market will adjust expectations as a result.

Is the focus on wages justified?

Comments from the ECB suggest that the main hurdle to a rate cut are wages, with unemployment at record lows. Pay growth, as tracked by recruitment platform Indeed, is down to 3.8% in December from 5.2% in October 2022, but the ECB wants to see it fall towards the 3% mark that is seen to be consistent with achieving 2% inflation. What makes ECB jittery is that 40% of European workers will be entering 2024 wage negotiations, and initial reports from IG BAU union suggest upward pressure continues. The salaries of steel-industry and public-sector employees will rise by more than 5% in 2025, while construction workers want a 21% increase for the lowest-paid majority.

However, wage data is lagging, and it is worth noting that headline inflation and inflation expectations have eased. December headline inflation came in at 2.9% YoY, higher than 2.4% YoY in November but due to base effects. Core CPI however eased to 3.4% YoY from 3.6% in November, and was the lowest since March 2022. ECB’s survey of inflation expectations have also pointed to both 1-year ahead and 3-years ahead falling quite sharply in November with the former sliding from 4% to 3.2% and the latter from 2.5% to 2.2%. Some analysts have argued that Eurozone inflation risks could return amid the shipping delays related to disruptions in the Red Sea

Meanwhile the Eurozone economy is starting to show cracks, and high real rates could bring further pressures if the ECB continued to wait for the wage data. Q4 GDP growth is only due on January 30, and a negative print will confirm that the Eurozone is in a recession after Q3 GDP growth came in at -0.1%. Even if the Eurozone managed to avoid a technical recession, the best case scenario would be that of a stagnation. November retail sales came in at -0.3% MoM and December Euro-area manufacturing PMI of 44.4, near a 3-year low, suggests that goods demand remains weak. Services PMI at 48.8 for December has remained in contraction for five straight months. Euro-area consumer confidence surprised on the downside as it dropped to -16.1 in January from -15.1 previously, reversing some of the improvement seen in the last 2 months. ECB Bank Lending Survey also noted credit standards tightened in Q4 for firms and households, with further tightening expected in Q1. In summary, the outlook for Eurozone growth is worsening fast, and may not leave room for the ECB to wait until the summer.