The December meeting of the European Central Bank has ended leading the markets to confirm their expectations that the central bank will lower rates by 50 basis points at the January meeting. Although investors are not buying the cut with a very high probability, it is the most likely scenario, if interest rate swaps are analyzed. There are those who may have been surprised by the change in message that the ECB has launched, by removing from its official speech the reference that rates must remain “in restricted territory”, but the new positioning of the central bank fits with the latest message that it has released by Philip Lane, chief economist of the ECB, in early December: Lane wants to refocus on future data, and not on past data, and according to this approach, There is an indicator that cries out for a strong rate cut by the BCE. These are long-term inflation expectations, also known as ‘5y5y’ inflation swaps, a data that confirms the ECB’s victory against inflationary pressures, and allows the central bank to consider aggressive rate cuts in the coming years. months.
The turn in the ECB’s official message has surprised some analysts, and also generated a rapid change in investors’ expectations of rate cuts, bringing forward the 50 basis point cut to the next meeting. To justify her decision, Christine Lagarde, president of the ECB, could have focused her message on an argument that Philip Lane, the central bank’s chief economist, launched at the beginning of December: “The time has come for monetary policy to look forward.” , and to scan the horizon to see which shocks can generate more or less inflationary pressures,” said the ECB’s chief economist.
This forward-looking orientation, which is based on the idea that the central bank should use leading indicators, and not past ones, was the key piece that Lagarde could have used to justify the change in the ECB’s discourse, and more, taking into account Note that the long-term inflation favorite indicator, the ‘5y5y’ inflation swap, is crying out for a strong rate cut in the euro zone. This indicator has sunk in recent weeks until falling below the 2% thresholdsomething that has not happened since mid-2022, and which confirms that, in the long term, the ECB will be able to meet its inflation objective.
Although it is true that the long-term inflation indicator has risen in recent days and is once again above 2%, the level of 2.03% that it now marks contrasts with those seen in recent years, in which it has moved above 2.5% on a regular basis. Thus, it is the missing piece in the ECB’s puzzle to justify a cut of 50 basis points, as the market expects.
‘Jumbo’ cut is not off the table
It is possible that some members of the ECB Governing Council have focused on these types of indicators to propose a cut of 50 basis points at this week’s meeting, following the recommendation of Lane, a member with significant weight within the ECB. central bank, and which recommends, in each monetary policy meeting, the decision that the Council should make, a guide that is usually strictly followed. We must not forget that Lagarde herself acknowledged this week that, at the meeting, the possibility of making a ‘jumbo’ cut was raised, a possibility that was finally ruled out.
In fact, François Villeroy de Galhau, the central banker of France and member of the Governing Council of the ECB, recognized this Friday that “the expectations of rate cuts that the markets maintain seem reasonable”, and he opens up to the fact that the year comes there will be “more rate cuts, in the plural”, admitting that he is “comfortable with the forecasts maintained by the financial markets”, in reference to the 50 basis point rate cut that investors are betting on at the moment.
Within the ECB there now seems to be a debate between hawks and doves, with those in favor of cuts of 50 basis points, and others, the hawks, who prefer that rates fall at a more sustained pace. In fact, on Thursday itself, the ECB’s leak to Bloomberg at the last minute, which pointed to rate cuts of 25 basis points, and denied its intention to lower them by 50, seemed an attempt to stop too aggressive expectations of cuts in its tracks, which may be a sign of lack of consensus among members such as Villeroy de Galhau, and others more in favor of maintaining high rates.
In the future, it is possible that Lagarde will use the evolution of long-term inflation expectations to justify a 50 basis point cut in rates, but for the moment it remains a ace up your sleeve. The search for a neutral interest rate now seems to be the most important task that the organization maintainsand the market, through the ‘5y5y’ indicator, is giving clues as to where it can be found.
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