The European Central Bank (ECB) is poised to proceed cautiously with interest rate cuts in light of mounting political uncertainties that pose risks to achieving its inflation target, according to a recent Bloomberg survey of analysts.
Following a modest quarter-point reduction in June, analysts anticipate a pause during the upcoming ECB meeting next week. Further rate cuts are expected to resume starting in September, occurring once per quarter until the deposit rate reaches 2.5% by the following year.
The gradual easing reflects the increasing challenges in predicting economic pitfalls for the euro zone, which comprises 20 nations. Inflationary pressures persist, and the recovery from months of stagnation may already be losing momentum. Meanwhile, elections, particularly in the United States, are prompting investors to reassess everything from fiscal policies to trade dynamics.
Analysts now identify the upcoming US presidential election in November, particularly the potential for another term for Donald Trump, as the primary threat to the region’s economy. Turmoil in France has also revived memories of the sovereign-debt crisis in Europe last decade.
Given this uncertain backdrop, ECB officials led by President Christine Lagarde are refraining from committing to a specific rate trajectory, emphasizing a data-dependent approach. Chief Economist Philip Lane and others suggest that July will primarily serve as an opportunity to assess the situation.
Market sentiment is more cautious than economist forecasts, with full pricing for only one more rate reduction in the deposit rate expected this year, albeit with a leaning towards additional cuts.
“There’s currently no urgency to continue reducing rates,” said Carsten Brzeski, Macro Head at ING. “Therefore, the ECB is likely to maintain its data-driven approach and refrain from providing forward guidance.”
Political factors are increasingly influencing economic outlooks. In the US, concerns about Trump are compounded by uncertainty over whether he will face President Joe Biden or another Democratic contender. Domestically, recent French elections have unsettled investors, although the situation has stabilized somewhat since the initial shock.
Bloomberg Economics analysts suggest that investors will closely monitor the ECB’s July 18 meeting to adjust their expectations for future rate cuts, despite expectations of no change this month. They anticipate Lagarde hinting at potential moves in September without committing firmly.
According to Scope Ratings economist Dennis Shen, only a minority of analysts expect the ECB to adjust its quantitative tightening plans in response to current events, with minimal expectations of any shift towards favoring reinvestments in France.
Looking ahead, concerns persist among analysts that economic growth may underperform while inflation could outpace the ECB’s projections from June. Notably, service sector costs remain a significant worry, driven partly by sustained wage increases.
Andrzej Szczepaniak, Senior European Economist at Nomura, noted, “Service-sector firms are reporting that supply constraints, rather than demand issues, are limiting their output expansion. Thus, persistent labor shortages and robust services demand pose risks of sustained inflationary pressures in the near and medium term.”
The upcoming ECB meeting is expected to be uneventful, with attention focused on whether September will be targeted for another rate cut.
Some analysts suggest that increasing chances of interest rate cuts by the US Federal Reserve may prompt the ECB in Frankfurt to act more swiftly.
“With the Federal Reserve signaling a potential return to interest rate cuts amid signs of normalization in economic and labor market data, the ECB should reconsider resuming rate cuts,” said Hlias Tsirigotakis, Economist at the National Bank of Greece.
Nonetheless, no rate reductions are anticipated at the upcoming meeting.
“Incoming data remains volatile, making it challenging for the Governing Council to ascertain the extent of economic rebound and the underlying inflation trend,” said Sylvain Broyer, emphasizing the unsettled political landscape in Europe and volatile debt markets.
