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Further analysis from the ECB: All options are open for the second half of the year!

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ECB officials continue to temper speculation about a rate cut. Following Ms. Lagarde’s hawkish comments yesterday, officials continued this morning: Inflation outlook remains uncertain And the central bank It has not committed to a specific interest rate path for the remainder of the year.

The ECB has cut interest rates 25 basis pointsBut as expected, it was a “hawkish” cut that leaves all options open for later this year, with Lagarde repeatedly stressing that any further decisions will depend on data, even refusing to acknowledge that yesterday’s move was the first step in an easing cycle. Rate cuts in September and December are still possible, but not confirmed.

Shimkus acknowledged that multiple rate cuts are likely this year, but overall, his comments were intended to quell speculation that the central bank had started a rate cutting cycle yesterday. Austrian Central Bank Governor Holzmann publicly admitted yesterday that he was the only one opposed to a rate cut. So far the doves have been silent, which confirms Lagarde’s hawkish message yesterday.

Rate cut details

The ECB cut interest rates for the first time in five years, lowering its key interest rate by 25 basis points. The deposit rate now stands at 3.75% and the key refinancing rate at 4.25%. This was a “hawkish cut” as short-term inflation forecasts were revised upwards and Lagarde noted that domestic inflation remains high. The statement stressed that the ECB was not committing in advance to a particular interest rate path, and comments said all options would be on the table later this year.

Economic Activity and Forecast

The ECB noted an improvement in economic activity in the first quarter of the year. Lagarde also highlighted that manufacturing is showing signs of stabilizing and that exports are expected to grow in the coming quarters, supporting growth. At the same time, monetary policy should not be a drag on demand over time, according to the ECB. The new forecasts show GDP rising by 0.9% this year, up from the 0.6% predicted in March. The forecast for 2025 was revised slightly downward to 1.4% from the previous 1.5%, and the ECB still expects a slight acceleration to 1.6% in 2026.

The inflation forecast for this year has been raised to 2.5% from 2.3%, and the projection for 2025 has been raised to 2.2% from 2.0%. As a result, inflation will fall towards the target more slowly than previously expected, but the forecast for 2026 remains unchanged at 1.9%. This means that headline inflation is still expected to be below target at the end of the forecast period.

Risk of rising inflation

The statement said upside risks to the inflation outlook from wages and profits could be higher than currently expected. Geopolitical tensions and extreme weather could also push up prices again, the ECB said. At the same time, the ECB acknowledged that inflation could be lower than expected if financial restrictions prove more restrictive than currently expected or if global growth weakens more than expected.

The press conference was mainly spent emphasizing that future decisions would depend on the data available at the time of each meeting. Lagarde even refused to confirm that the central bank had effectively started an easing cycle, saying when asked that it was not necessarily true that the ECB had started a “tapering process.” She hinted at that possibility but refused to confirm it. This means that in theory interest rates could indeed rise again.

While this seems unlikely, as the decision was nearly unanimous, it is clear that the ECB will not be lowering interest rates at every meeting, and that the outlook for the rest of the year is still very much open. The ECB believes that it will need to keep monetary policy tight for the time being, given the backdrop of high domestic inflation. However, as Chief Economist Lane recently suggested, whether the central bank can ease the tightening will be something officials will have to discuss at each meeting.

Employment and inflation trends

Wage growth, profits and service price inflation will remain key figures to watch for the rest of the year. Lagarde pointed to employee compensation data to be released tomorrow, but also noted that current wage agreements often remain backward-looking, as they reflect attempts to compensate for the steep price increases since the start of the Ukraine war. As previously noted, Germany’s multi-year wage agreement is a good example. However, as Lagarde highlighted, the agreements under negotiation so far indicate a strong increase this year, but also slower wage growth in the coming years.

However, unemployment is at an all-time low and job openings have only slightly decreased. At the same time, service price inflation remains high, suggesting that companies have ample room to pass on rising labor costs. With real disposable income rising due to lower inflation and higher wages, it will be easier for companies to raise prices later this year, and yesterday’s interest rate cut will also boost demand. In the current environment, this could intensify price pressures domestically.

The only thing clear about what lies ahead is that Lagarde has done her best to tamp down expectations of further rate cuts: There is still a chance that the ECB could cut rates by another 25 basis points in September and December, but nothing is set in stone at this point.

click here Access the economic calendar

Andrea Piccidi

Market Analyst

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