ECB: Next Stop, June

While market pricing looks more reasonable, European Central Bank rate cuts, which could commence in June, are unlikely to be delivered as aggressively as the market expects in 2024.

The European Central Bank (ECB) acknowledged the progress made on inflation and left its policy rate unchanged at 4% in March. It did not discuss rate cuts. While the ECB again expressed increased confidence regarding inflation in the eurozone, the Governing Council (GC) refrained from declaring victory. It instead highlighted the need to remain attentive to the different forces affecting inflation and focused on bringing it back to its 2% target.

More than three 2024 cuts have been priced out since late last year and market pricing seems more reasonable as a result. At close to four rate cuts this year, market pricing is currently not far away from our baseline expectations of three cuts in 2024; hence we remain somewhat skeptical versus the market. This skepticism is based on “sticky” services inflation, a resilient labour market, loose financial conditions, the potential for renewed supply chain disruptions, and ECB risk management considerations.

Given the ECB’s current decision-making is based on the inflation outlook, underlying inflation dynamics, and policy transmission, we believe it will likely commence the rate-cutting cycle at one of its staff projection meetings – and the June meeting might constitute the first live meeting. Once the ECB does start to cut rates, we believe it will proceed cautiously in conventional 25-basis-point steps, unless the data suggest a solid undershoot of inflation in the medium term.

As for investment implications, current valuations leave us broadly neutral on European duration in the near term. Amidst elevated issuance needs, ending reinvestments weakens the relative technical picture for government bonds, and speaks to a continued rebuild of term premia over time. We expect the back end of interest rate curves to underperform relative to shorter maturities.