The ECB's interest rate cut cycle starts! What will be the path after June?

CBN

2024-06-07 07:26Posted on the official account of Shanghai Yicai

Without any suspense, the ECB today (June 6) preemptively led the Fed to start its first interest rate cut, reducing the main refinancing rate to 4.25%, the marginal lending rate to 4.50%, and the deposit facility rate to 3.75%. This is the first time since March 2016 that the eurozone's main refinancing and lending margins have been cut, and the deposit rate has been cut for the first time since September 2019.

The ECB said inflation has fallen by more than 2.5 percentage points since the ECB meeting in September 2023 and the inflation outlook has improved significantly, reiterating its plan to reduce its PEPP portfolio in the second half of 2024. But the ECB also reaffirmed its determination to bring inflation back to 2% in a timely manner, and that the data will determine the level and duration of restrictive measures, and decisions will be made on a meeting-by-meeting basis based on economic data. Interest rates will remain sufficiently restrictive for as long as necessary, with no pre-commitment or forward guidance on any particular interest rate path.

In terms of economic growth and inflation forecasts, the ECB raised its inflation forecasts for 2024 and 2025. Specifically, the ECB expects inflation to be 2.5% in 2024, 2.2% in 2025 and 1.9% in 2026, compared to 2.3%, 2.0% and 1.9% in March. The ECB also raised GDP growth to 0.9% in 2024 from 0.6% in March, but lowered economic growth to 1.4% in 2025 from 1.5%.

As senior ECB officials, including ECB President Christine Lagarde, have recently issued frequent signals, the market is not surprised by this decision. Therefore, the market is more concerned about the ECB's guidance on the subsequent path of interest rate cuts than the interest rate decision itself.

After the decision was announced, the money market now expects the ECB to cut interest rates by another 59 basis points this year, compared to 64 basis points before the decision, that is, the market still expects the bank to cut interest rates a total of 2~3 times this year. In addition to the June meeting, the September and December quarterly meetings will be of particular interest, as more data on wages, corporate profits and productivity will be available at these meetings.

In addition, for European stock investors, the ECB's interest rate cut is undoubtedly good news, because in the opinion of many analysts, this move will help European stocks consolidate their gains.

What about after June?

As the rate-cutting cycle kicks in, the ECB faces the challenge of balancing the risk of cutting too much with too little. If monetary policy is loosened too quickly and sharply, it could further boost consumer demand and investment, leaving the eurozone, which has not yet reached its 2% inflation target, at risk of a rebound in inflation again.

Based on various balance considerations, although the ECB withstood the pressure to cut interest rates for the first time, after the data showed that European economic growth, inflation and wage growth were still stronger than expected, analysts generally believe that after the first interest rate cut, the ECB will remain cautious, and it is not expected to act again in July, cutting interest rates 2~3 times this year.

Frederik Ducrozet, head of macroeconomic research at Pictet Wealth Management, told CBN that our focus is on what will happen after June. As predicted, the ECB's Governing Council has maintained its current practice of relying on data and making decisions on a meeting-by-meeting basis based on economic data. In fact, the ECB also has the option of clearly indicating the interest rate decisions that will be made on a quarterly basis in the future, supplemented by the latest staff macroeconomic forecasts. The latter approach appears to be gaining popularity among "hawks," he said, with Klaas Knot, the governor of the Dutch central bank, explicitly supporting the latter in a speech this week. This approach would ensure that the market's expectations of the ECB's future interest rates are reflected in the current pricing of markets, and that this pricing will be used as a variable that in turn will affect future interest rate expectations and prospects, in line with the ECB's return to inflation policy targets next year.

"This may sound like a circular self-justification, but it applies to the broader environment of heightened uncertainty about the inflation outlook in the eurozone and dovetails with the ECB's heavy reliance on data." Du Zefei said.

In addition, he said that the ECB's forecasts on the economy and inflation this time are another focus of market attention. "Since March, a number of technical assumptions have changed, driving some of the more hawkish marginal changes at the policy level. Eurozone GDP growth and inflation forecasts for 2024 should also be revised upwards slightly to reflect recent developments. "These marginal changes, combined with the stickiness of Q1 wage growth and strong services inflation in May, released last week, will continue to support the more hawkish view of the ECB that a rate cut in July is unnecessary." Our current forecast is also that the ECB will remain on hold in July after cutting interest rates for the first time in June. "

In fact, many ECB ECB members have spoken out against a second consecutive rate cut in July. Executive committee member Schnabel and Bundesbank President Nagel said they do not believe there will be any further rate cuts in July. Austrian central bank governor Holzmann even said that two rate cuts throughout the year might be enough.

Carsten Brzeski, head of macro at ING, told CBN: "In the past, the first rate cut was always followed by further rate cuts to support economic growth and/or respond to the crisis. But this time, neither of these scenarios exists. Therefore, it is likely that the ECB will move from a 'once is not enough' to a 'one-time job done' stance of cutting interest rates. "

However, in any case, it is still the general consensus of the market to cut interest rates three times this year.

In an email reply to CBN, the PGIM Fixed Income analyst team said that we still expect the ECB to cut interest rates by a total of 75 basis points throughout 2024, bringing the eurozone policy rate to 3.25% by the end of the year.

The Barclays research team wrote in a research note shared with CBN reporters that the latest data will indeed give the ECB reason to be cautious about the prospects for easing policy. The team expects the ECB to cut rates by a further 25 basis points each at its September and December interest rate meetings. Thereafter, the ECB should be more confident in wage dynamics and disinflationary trends in the services sector and accelerate the pace of monetary easing, cutting rates by another 25 basis points in January and March 2025, before cutting rates by a final 25 basis points in June 2025. In other words, the ECB will cut interest rates by a total of 150 basis points in this rate cut cycle, and the final deposit rate will be 2.5%, which is at the upper end of the bank's forecast range for the eurozone neutral rate.

The bull market in European stocks is expected to continue

Regardless of the prospect of a rate cut, European equity bulls may have found a reason to revel, at least temporarily. While the Fed's interest rate cut prospects remain uncertain, the Euro Stoxx 600's record year-to-date rally has room to continue on the back of the ECB's rate cuts, market participants said. European equities have risen 8% so far this year. Today (June 6), the Stoxx 600 index briefly hit a record high in anticipation of a rate cut by the European Central Bank. Germany's DAX 30 index, France's CAC 40 index, Spain's IBEX 35 index, and Britain's FTSE 100 index also rose across the board.

History has shown that relatively looser monetary policy is generally good for the stock market. An analysis by Goldman Sachs shows that since the '80s, European stocks have risen 2% in the month following a rate cut, about twice as much as European stocks have risen in any other month. The data also shows that if rate cuts are accompanied by strong economic growth, the subsequent 12 months tend to be much stronger.

Lilia Peytavin, a portfolio strategist at Goldman Sachs, said: "The current policy mix in the eurozone is a pretty good mix for equities. We expect Eurozone economic growth to rebound in the coming quarters, which should be a good thing for so-called cyclical equities. "

Luca Paolini, chief strategist at Pictet Asset Management, said the year-to-date gains in European equities have partly priced in some optimism, and while this limits the likelihood of a "significant rebound" in equities following the ECB's rate cut, it is "not insignificant". "Perhaps European stock prices have priced in interest rate cut expectations, but given that the European economy and corporate fundamentals are also slowly moving in the right direction, the psychological impact cannot be ignored." He said.

Thomas Zlowodzki, a strategist at the agency Oddo BHF SCA, said that the ECB's first interest rate cut, the easing of political uncertainty after the European Parliament elections this weekend, and the rebound in economic growth are enough reasons to remain optimistic about European stock markets. The combination of these factors led him to believe that "mid-June may be the right time to increase his exposure to European equities".

Some analysts have stressed that interest rate factors may also be more favourable for European equities in the medium term. Citi strategist Beata Manthey said in a research report that the eurozone benchmark interest rate may eventually end up at around 2%, which is lower than the current level but higher than the zero interest rate of the past decade. This may be more helpful for investors to choose Europe, as cyclical stocks in the eurozone "were better able to outperform US equities in a non-zero-interest rate world before the global financial crisis."

(This article is from Yicai)

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