ECB: Eyeing a June Rate Cut

The European Central Bank (ECB) expressed increased confidence in the inflation path ahead at its April meeting, as supply shocks continue to reverse and risks to the inflation outlook balance out. Recent wage data indeed do not suggest significant upside risks to the ECB’s latest macroeconomic projections.

If incoming data, notably in relation to wages and corporate profits, broadly confirm the scenario foreseen in its March projections, we believe the ECB will start dialing back its restrictive monetary policy stance. Given the ECB’s reaction function (which is based on the inflation outlook, underlying inflation dynamics, and policy transmission) we expect it to commence the cutting cycle at one of its staff projection meetings – and a June rate cut seems increasingly likely.

These developments follow the March meeting, when the ECB Governing Council began discussing dialing back its restrictive stance, but was not yet sufficiently confident and expressed a desire to move further along the disinflationary path.

Once the ECB starts to cut rates, we expect it will proceed cautiously in conventional 25-basis-point steps. During the cutting cycle, decisions will likely remain data dependent and meeting-by-meeting, with the ECB unlikely to pre-commit to a particular rate path. The market is currently pricing an 80% probability for a cut in June, about 75 basis points of rate cuts for this year, and a terminal rate of around 2.5% at the end of 2025.

This pricing seems reasonable, and is in line with our expectations for three cuts this year. As a result, current valuations leave us broadly neutral on European duration overall. We continue to expect the back end of interest rate curves to underperform relative to shorter maturities, mainly based on a rebuilding of term premia over time (see our recent PIMCO Perspectives on this topic).