The ECB removed a key inflation warning from its policy statement on Thursday, even as Christine Lagarde attempted to talk markets out of aggressive bets on rate cuts commencing as soon as March.
For quite a while, the bank’s communications with markets contained some version of a phrase that indicated inflation would “remain too high for too long.” That passage vanished from the policy statement on Thursday.
“While inflation has dropped, it is likely to pick up again temporarily in the near-term,” the ECB said. Recall that inflation in Europe receded more quickly than many expected in recent months, including in November, when headline price growth slowed to just 2.4%.
Even some of the Governing Council’s more hawkish members were compelled to acknowledge the declines and also the read-through for policy: Rate hikes were finished. Thursday’s statement underscored that point, while insisting that the GC will hold terminal as long as necessary.
“Based on its current assessment, the Governing Council considers that the key ECB interest rates are at levels that, maintained for a sufficiently long duration, will make a substantial contribution to [ensuring inflation returns to target],'” familiar language read. “The Governing Council’s future decisions will ensure that its policy rates will be set at sufficiently restrictive levels for as long as necessary.”
Naturally, markets are looking ahead to rate cuts. Lagarde, in her remarks to the press, tried to play down any such speculation. “We should absolutely not lower our guard,” she said. And then, later: “We definitely did not discuss rate cuts today.” That made for a pretty stark contrast with Jerome Powell, who on Wednesday said the Fed did indeed begin discussing a timeline for prospective cuts at this week’s meeting.
The updated ECB staff projections see headline and core inflation averaging 2.7% in 2024, before falling back to target in 2025. “Underlying inflation has eased further but domestic price pressures remain elevated, primarily owing to strong growth in unit labor costs,” the ECB said.
Staff expects growth to pick up from an average of 0.6% in 2023 to 0.8% next year. In September, staff saw growth averaging 1% in 2024. A year ago, the 2024 growth projection was 1.9%. “The past interest rate increases continue to be transmitted forcefully to the economy,” the bank said Thursday. As a quick reminder: Europe is either in a mild recession or very close to one.
Finally, the ECB previewed PEPP QT. Recall that the bank has two QE programs: Regular (APP) and the pandemic asset purchase program. APP reinvestments stopped a long time ago, but the PEPP guidance (i.e., reinvestments would continue at least until the end of next year) was unchanged meeting after meeting. Until Thursday.
“The Governing Council decided today to advance the normalization of the Eurosystem’s balance sheet,” the bank declared. The PEPP portfolio will shrink by €7.5 billion per month starting in the second half of next year. PEPP reinvestments will be discontinued at the end of 2024.
Taken as a whole, you could argue Lagarde and the ECB did a better job than Powell and the Fed at threading the needle this week. It’d be somewhat nonsensical to call the ECB decision a “hawkish hold.” They aren’t going to hike again. But Lagarde’s messaging and the PEPP QT announcement were a prudent offset to the more dovish view around the inflation outlook.
