Weekly Update - European Central Bank: a gradual pivot without any rush

European Central Bank: a gradual pivot without any rush

The European Central Bank (ECB) has lowered their policy rates, as widely expected. However, the upward revision in inflation forecasts and the somewhat hawkish tone of the press conference suggest a cycle of interest rate cuts that will remain gradual, leading to a modest adjustment of market expectations.

The ECB has ended nine months of status quo by lowering its three key interest rates by 25 basis points. The interest rates for the main refinancing operations, marginal lending facility, and deposit facility will be reduced to 4.25%, 4.50%, and 3.75% respectively, starting from 12 June 2024. This action confirms the central bank's intention to soften the restrictive stance of its policy, in a context where inflation has already significantly decreased compared to its peak at the end of 2022. Simultaneously, the ECB continues its policy of gradually reducing the size of its balance sheet.

Upward revisions to its growth and inflation forecasts. The institution now predicts a stronger rebound in economic activity in 2024, with growth forecast at 0.9% (up from 0.6%), then 1.4% in 2025 and 1.6% in 2026. This revision reflects positive surprises in economic activity indicators, with stronger than expected growth in the first quarter and leading indicators suggesting continued improvement. The ECB also predicts that headline inflation will remain above its 2% target for longer, with an average inflation rate forecast at 2.5% in 2024, 2.2% in 2025, and 1.9% in 2026. This revision takes into account the latest inflation figures (headline increased to 2.6% year-over-year in May from 2.4%), but more significantly, the unexpected wage pressures at the start of the year. In addition to these upward revisions to inflation forecasts, Christine Lagarde has notably taken a cautious tone regarding the future trajectory of inflation and therefore, interest rates.

Markets acknowledge the ECB's cautious stance. The ECB's interest rate cut has been followed by a slight increase in money market and bond yields – albeit modest. Markets are now ruling out a second interest rate cut from the ECB in July and are taking note of the ECB's caution. However, they still anticipate around 50 basis points of further interest rate cuts by the end of 2024. In a context where economic activity is still hindered by the slowdown in bank lending activity, we also anticipate the continuation of the ECB's interest rate cut cycle, with two more cuts in the second half of the year.

In the highlights of the week, we chose to talk about economic activity and the job market in the United States as well as inflation and growth in Switzerland:

• US economic figures for May were mixed. The ISM index showed a stronger-than-expected contraction in the manufacturing sector, at 48.7 against the expected 49.6, but a stronger-than-expected growth in services, at 53.8 against 50.8 expected. Indicators show a softer price component, which reassures markets about the direction of inflation. The US economy created 272,000 non-farm jobs in May, more than the consensus expected (185,000). However, the unemployment rate increased to 4% when the consensus expected 3.9%. Wages, meanwhile, accelerated to 4.1% year-on-year, higher than the consensus expected (3.9%). Therefore, the direction of inflation in the US remains uncertain and is causing markets to doubt the Federal Reserve's ability to lower interest rates in the near future.

• The inflation rate in Switzerland remained unchanged at 1.4% year-on-year in May, the highest level since the start of the year. The only components that accelerated over the month were housing and transportation, suggesting that inflation is under control. Furthermore, economic growth in Q1 positively surprised at 0.5% quarter-on-quarter compared to the expected 0.3%. Therefore, while markets expect one or two rate cuts from the Swiss National Bank (SNB) this year, they are now leaning towards the status quo at its meeting on 20th June, given that inflation is not accelerating but remains high (according to the country standards) and growth is more robust than expected.

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