Increasing Specificity in ECB Communications
Recent statements from ECB officials indicate a growing level of detail in their communication, bordering on forward guidance, which is likely to be a focal point in the upcoming policy meeting.
Economic Overview: Persistence of Weakness
Since the December meeting, there has been minimal change in the Eurozone’s economic landscape, with indicators suggesting continued sluggishness. Key PMIs hover just above their lows, signaling contraction in both manufacturing and services sectors. While retail sales show slight resilience, consumer spending remains subdued, and industrial production has seen consistent year-on-year declines since March, potentially leading to a technical recession by the end of the year.
Moderation in Price Pressures
Although headline inflation in December rose to 2.9% from November’s 2.4%, primarily due to energy price effects, core inflation decreased to 3.4%, its lowest level since March 2022. Additionally, consumer inflation expectations for the next 12 months dropped to 3.2%, down from 4% previously. The 2y2y inflation swap rate also fell to below 2.1%, indicating growing confidence in taming price pressures.
Balancing Policy Easing and Market Expectations
The economic reality in the Eurozone increasingly supports the case for policy easing, although the ECB must be cautious to prevent excessive rate-cut speculation. Market expectations for rate cuts have slightly eased, with markets now anticipating roughly 130bps of cuts through 2024, down from around 160bps at the beginning of the year. The ECB’s January communications are expected to aim at avoiding heightened rate-cut expectations while emphasizing the importance of data dependence.
Focus on Summer Rate Cuts and Market Reaction
Attention will be on the possibility of rate cuts in the summer and any indications of pushback against market pricing. While investors currently assign a 65% implied probability of a rate cut in April, recent statements from ECB members suggest that an April cut is becoming increasingly less likely. Market reaction, particularly in EUR/USD dynamics, could see volatility around the time of the press conference, with expectations largely set on the April meeting as the start date for cuts. However, any messaging from the ECB is not expected to be overly forceful due to concerns about cornering itself.