ECB: The first cut, but not the deepest cycle

Bottom line: Unlike the Fed, the case for a first ECB rate cut in June has strengthened. But the jury is still out on the pace of cuts afterwards. Investors should keep the big picture in mind: rates in the euro area will likely stay structurally higher than before the pandemic. This rate cutting cycle will not be as deep as previous ones.

- First cut in June, then data-dependent. As expected, the ECB kept policy rates on hold today. Yet President Lagarde reaffirmed that a first rate cut is likely in June – provided the data comply. Notably, the jury is still out on the pace of cuts after that. Lagarde reiterated that the ECB will follow a “data-dependent, meeting-to-meeting approach”.
- ECB ahead of the Fed. Compared with the Fed, the ECB faces weaker growth and has hiked policy further into restrictive policy. Recent strong jobs growth and sticky inflation now makes a Fed cut in June unlikely. So, the ECB will probably cut first, but may then move more slowly if the Fed delays cuts.
- Sticky inflation means a shallow easing cycle. As the energy shock unwinds and past ECB rate hikes bite, we expect euro area headline inflation to reach – or even temporarily undershoot – the ECB’s 2% inflation target in 2024. But this is not a return to the world we once knew, where inflation was consistently well below the 2% target. With labour markets still tight and productivity weak, domestic price pressures could keep inflation near or above 2%. Investors should keep the big picture in mind: rates in the euro area will likely stay structurally higher as inflation settles above pre-pandemic levels.