ECB Preview: Confidence vs uncertainty – Deutsche Bank

ECB to continue to cut on 30 January with another 25bp reduction in the policy rate to 2.75%, and markets expect the description of the policy stance to be unchanged vs December, Deutsche Bank’s analysts report.

ECB to cut by 25bp at each of the four meetings in H1

“The interpretation between the lines will be consistent with further rate cuts: the policy stance will continue to be described as restrictive and the ECB will remain confident that inflation is on the right track. There will be no pre-determined path for policy and the terminal rate will be above/at/below neutral depending on the data which the ECB will judge meeting-by-meeting. The main risk in January is that the tweaks to the description of the recent data lean a little hawkish relative to December (e.g., higher energy prices, domestic inflation unchanged).”

“In this Preview, we explore the potential tension between the ECB’s growing confidence in the return of inflation to target and the increasing two-sided risks around this central view. These views are consistent with a return to neutral but at a gradual pace. That is, it would require a shock for the ECB to cut by 50bp. We also think about neutral rates and when the ECB might start to “tiptoe” or slow the pace of cuts from the current 2 quarter-point cuts per quarter to one cut per quarter - we think from Q3, the risk is Q2. Finally, we think about the macro data that will be most important to the ECB when making these decisions.”

“Our baseline call on the ECB is unchanged. We expect the ECB to cut by 25bp at each of the four Governing Council meetings in H1, lowering the policy rate to 2.00% by mid-year. In H2, we expect the pace of cuts to slow. We expect one 25bp cut per quarter in H2 – cuts at the September and December meetings – with a terminal rate of 1.50% at year-end, modestly sub-neutral. This view is predicated on the assumption of below-trend growth, moderately below target inflation and risks to inflation that are skewed to the downside.”