Lagarde Offers No Guidance on Next ECB Decision
ECB rate could attract investment into European assets
The European Central Bank (ECB) lowered its key interest rate by 25 percentage points as supply shocks unwind and inflation slows towards its 2.0% target, a decision seen as rolling back the “insurance hike” from last September and diverting from US Federal Reserve policy.
ECB President Christine Lagarde said in a news conference after the policy decision that "inflation is expected to fluctuate around current levels for the rest of the year, including due to energy-related base effects, and then expected to decline towards our target over the second half of next year."
"The risks to economic growth are balanced in the near term but remain tilted to the downside over the medium term,” she said without committing to a ”particular rate path.”
Markets initially reacted negatively as they were expecting a clearer signal of more rate cuts. Then, euro and Eurozone bond yields rose while equities trimmed gains following the higher inflation warning. EURUSD spiked but ended the session on June 6 mixed.
The US Federal Reserve is unlikely to follow the ECB decision. The difference in monetary policy between the two central banks could lead to a stronger US dollar and potentially lower commodity prices. Lower rates in Europe might attract more investment into European assets, if the currency loses purchasing power.
Inflation In-Line With Expectations
New projections from the ECB show headline inflation averaging 2.5% from 2.3% in 2024 and 2.2% from 2.0% in 2025, offering slightly higher variations compared with March projections.
Although inflation is slowing in the Eurozone, economic growth is picking up, limiting the scope for rate cuts. The ECB revised its short-term growth forecasts higher for 2024 to 0.9% from 0.6% but lowered its 2025 forecast to 1.4% from 1.5%.
ECB chief economist Philip Lane warned during a May speech in Dublin that "keeping rates overly restrictive for too long could push inflation below target over the medium term." This would “require corrective action through a subsequent acceleration in rate cuts that could even require having to descend to below-neutral levels,” he said.
Inflation in the Eurozone fell to 2.4% in March from 2.6% in February, led by lower food and goods price inflation, while services price inflation remained high at 4.0%. Although it was expected to fluctuate around these levels in the upcoming months, it rose to 2.6% in May, above expectations of 2.5%, due to strong services inflation increasing from 3.7% to 4.1%.
Rate Cut Estimates
Following April’s inflation report, the ECB is unlikely to cut interest rates in September, given its strong start to 2024, Danske Bank analyst Piet Christiansen said in a note.
"We have revised our ECB rate path for the first time in more than 12 months and now expect the ECB to deliver two rate cuts this year (June and December), and three cuts next year," he said.
Market expectations for ECB rate cuts this year have fallen from up to six cuts to just one more after the widely expected June cut. Economists forecast the ECB could make two more rate cuts, while analysts see signals of multiple rate cuts this year.
“The slight upgrade to the inflation forecast was to be expected, inflation has been printing a little bit hotter than markets were expecting, but in terms of the timing of the next cut I’d still be looking to September,” chief Eurozone economist at UBS Global Wealth Management said on CNBC.
Wages Profile Normal
Some ECB policymakers have been concerned about rising wages, arguing that it threatens their ability to meet their 2% inflation target. Others have argued that current wage trends are a natural response to the energy shock following the 2022 Russian invasion of Ukraine and expect wage growth to decelerate, which should, in turn, keep inflation in check.
Although wage growth has been rising to compensate for real income losses following the pandemic, it still remains below 2020 levels, and the higher negotiated wage growth recorded in Q1 was attributed to one-off payments in Germany.
ECB wage tracker data for early 2024 show that pressures from negotiated wage growth are moderating, suggesting they are set to decelerate.
The ECB said on March 27 that a catch-up of wages in real terms in 2024 is compatible with reaching the 2% inflation target, especially since the bank targets goods produced domestically as well as internationally in its benchmark harmonized index.
While “wages matter enormously” for the ECB, the central bank does not see the current real wage growth as a major threat to its inflation target. The ECB expects real wages to moderate after 2024’s bumpy road to a level consistent with productivity growth and the 2.0% inflation target.
The bank’s narratives on wages have been inconsistent, though. Initially, the bank argued that falling real wages were normal due to deteriorating terms of trade, but seems to accept rising wages now that trade terms are improving.
Prospects in EU Stocks
The shift to normalization may boost financial services companies preeminently as mortgage rates will be in actual fact reduced from June 12, making borrowing more affordable and in turn increasing demand for mortgages.
Hypoport AG (HYQ.DE) operates a digital platform for mortgage brokers and lenders in Germany, a country with long waits for affordable apartments. It stands to benefit from increased demand for mortgage or refinancing applications that would result from lower rates.
The company has a forward P/E ratio of 116.1 multiple, currently at a much lower P/E of 84.84 multiple, suggesting significant growth expectations from a large institutional block owning 46.58% of shares, after it posted EPS growth of 462.50%.