Deposit rate cut to 2.5% fully expected
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Trade war, German spending boom to transform outlook
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Reference to ‘restrictive’ policy is key to watch
(Adds jump in inflation expectations, paragraph 13, economist comment paragraph 9)
By Balazs Koranyi and Francesco Canepa
FRANKFURT, March 6 (Reuters) – The European Central Bank is set to cut interest rates again on Thursday in what is likely to be its last easy decision for a while as trade wars and rearmament drive the continent’s biggest economic policy upheaval in decades.
With the outlook shifting at a faster pace than economic models can match and its policymakers increasingly split about the need for more support, the focus will be on what signals the ECB sends about future moves.
After cutting borrowing costs rapidly over the past nine months on faltering growth and retreating inflation, the euro zone’s central bank has already telegraphed another 25 basis point reduction in the deposit rate on Thursday, to 2.5%.
The outlook beyond that is more complicated.
Rates are slowly approaching a level that no longer restricts economic growth, which might normally herald an end to the easing cycle.
But these aren’t normal times.
A trade war with the United States is looming and growth, hovering near zero, is already taking a hit as firms hold back investment, fearing that extended conflict will hurt demand.
Meanwhile Germany and the European Commission have both announced transformational changes in fiscal rules to boost defense and infrastructure spending, partly to replace U.S. support – a tectonic shift that could impact growth for years.
“With inflation under control and oil and gas prices back on the decline, another cut from the ECB looks all but nailed-on,” HSBC economist Elizabeth Martins said.
RESTRICTIVE?
The ECB will struggle to keep up with the rapid change in the outlook.
Its new economic projections, based on data collected weeks ago, are likely to show weaker growth and a slightly higher inflation trajectory.
But policymakers will be more pragmatic, recognizing that the world has moved on since the cut-off date for the forecasts and that they now face exceptional uncertainty.
While more spending is better for growth, it could also add to price pressures, and measures of longer-term inflation have surged from around 2.05% early this week to 2.23% by Thursday, an unusually large shift.
But the ECB does not act on short-term volatility so that change will not be enough for now to alter the debate.
“For the ECB, we think this changes little, but it does point to upside risks around the outlook,” Jefferies said in a note. “The prospect of fiscal loosening could add to considerations about where rates will settle at the end of this cutting cycle.”
The key to look for on Thursday is whether the ECB maintains its language that policy “remains restrictive” or drops it, which would suggest policymakers feel they are close to achieving their aim.
But even removing that phrase would not necessarily mean a pause – instead, it could signal greater uncertainty and a noisy debate in the weeks leading up to the next policy meeting.
The ECB’s projections themselves embed market bets on rate cuts, so if inflation is still seen at 2% by the end of the year, then two more rate cuts will remain the ECB’s base case.
Also suggesting that easing has room to run, the ECB’s models show the deposit rate stops restricting growth in the 1.75% to 2.25% range.
Another item to watch is whether ECB President Christine Lagarde maintains her line that the direction of policy is clear and only the timing and magnitude of easing up for debate.
For kingslot96 now, investors think the ECB will keep going, even if a surge in budget spending could eventually change the outlook.
“The potential for a huge fiscal impulse has suddenly rewritten the medium-term outlook, leading to speculation about whether they’ll stop cutting quicker than previously thought,” Deutsche Bank’s Jim Reid said.
Markets are pricing almost two more rate cuts this year after Thursday’s move, slightly less than before Tuesday’s German budget announcement but still broadly in the range of expectations seen in the past few weeks. (Editing by Catherine Evans)
