The last meeting of the year of the European Central Bank has convinced the markets that the organization is going to step on the accelerator in the pace of rate cuts in the coming months. After lowering the price of money by 100 basis points in the last months of 2024, ahead of the January meeting, investors have begun to discount a ‘jumbo’ rate cut, that is, 50 basis points, double the usual. The new expectations of investors are based on the new official speech of the ECB, which has eliminated from its message the need to “maintain interest rates in sufficiently restrictive territory for the necessary time.” This change in official discourse, and this is how the markets have interpreted it, confirms that The ECB has pivoted its monetary policy approach and now believes it is more necessary to support growth than fight inflation.
The president of the European Central Bank (ECB), Christine Lagarde, has left a widespread feeling that the ECB has just give a turn to its monetary policy positioning at this Wednesday’s meeting. The change that has occurred in the official discourse has convinced the markets that the ECB is no longer so worried about inflation, and is going to focus its efforts on giving a boost to the economic growth of the euro zone, to try to speed it up. at a time when it is slowing down.
“Although the rate movement was widely expected, and was already fully discounted by the markets, the speech has eliminated a reference that has been present for a long time, that a monetary policy that was restrictive was needed,” explains Matthew Ryan, director of market strategy at Ebury. “We consider this a new clear sign that the attention of monetary policymakers has shifted away from controlling inflation.something that now seems to have been achieved, coming closer to becoming a support for the economic activity of the euro zone,” confirms Ryan.
In fact, the cut in economic growth and inflation forecasts has caused the ECB to confirm, through Lagarde, that “the disinflation process is very well underway“, and recognizes, although with a small mouth, the success that the central bank has had in its fight against inflationary pressures in recent years. Lagarde, as a good prudent monetary policy, has made it clear at all times that this whole scenario that The outlook now for the future can change quickly, and the central bank will be ready to adapt, if necessary. In his opinion, the risks for inflation “now come from both sides”, indicating that there are still elements that can put pressure on the economy. rise to the CPI and force the bank central to having to pivot its monetary policy approach again. It is a warning to watch your back, but the reality is that the central bank is already beginning to claim victory in its fight against inflation.
In search of the neutral type… and beyond
The European Central Bank no longer believes that monetary policy should remain restrictive, but recognizes that, with interest rates at current levels, it is still. That is why markets expect an acceleration in rate cuts in the coming months, with the 50 basis point drop priced in for the next meeting: the ECB needs to accelerate if it wants to achieve a policy positioning that is not restrictive. .
But what is a restrictive monetary policy? And, above all, what has to happen for it to stop being so? A monetary policy is considered restrictive when it slows economic growth and inflation. That is, the tools used by the ECB, such as interest rates (the most important), contribute to cooling economic activity, with high rates that make it difficult to grant credit and make borrowing more expensive, which reduces the capital available in the real economy.
Monetary policy can be neutral, if it does not affect activity, neither stimulating it nor slowing it down. And finally, it can be accommodative, if it stimulates growth and inflation, with low rates. Finding the point at which monetary policy is neutral has become in recent months the great debate of central banks such as the ECB and the Fed, which are looking for what level it marks, where it begins and ends, both monetary restrictive as well as accommodative.
Although it is not a simple question, and there is still debate about it, today most analysts, and The ECB itself considers that the neutral interest rate is 2%, or in other words, a real interest rate of 0%. (the real interest rate in the euro zone is the one established by the ECB when the inflation rate is subtracted). Therefore, with the ECB rate at 3% at this time, and discounting inflation that was within the ECB’s target of 2%, it would mean that the real rate is 1%.
Taking this into account, so that ECB policy stops being restrictive, the central bank should lower rates by another 100 basis points. Then, the real rate would be stuck at 0%, and would be neutral, in the opinion of the central bank. According to this same logic, for monetary policy to be accommodative, it should go somewhat lower, and fall to -0.25%, in real terms, which would mean lowering the ECB’s reference rates to 1.75%, with inflation at 2%, as the ECB expects for the coming years.
For To achieve this, the ECB would have to cut rates by 125 basis points, and this is exactly the scenario that investors are contemplating at this moment.: a rate cut of 50 basis points in January, which will be followed by another 3 of 25 basis points in the following months. In this way, Lagarde has put an end to the last few years in which monetary policy had to be restrictive. Now, the idea is to prevent the economy from slowing down excessively, with an accommodative approach when the time comes. And for investors, this moment will be the summer of next year.
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