Expectations of ECB interest rate cut in Q2 grow stronger

The European Central Bank will reduce interest rates next quarter, according to a Reuters poll, with 45 per cent of respondents saying the reduction in borrowing costs would happen in June. The poll, which was released on Thursday, also showed the first ECB rate cut was more likely to occur earlier than expected than later. As inflation moves closer to the ECB's 2 per cent target, the next move is almost certainly a cut, but the timing is still up for debate.

Investors are currently pricing in around 150 basis points of cuts this year, with the first reduction expected in April, despite pushback by some members of the central bank's Governing Council against the aggressive easing calls. While economists also expect the first rate cut next quarter, they differ from financial markets on the timing. All 85 respondents in the January 12-17 Reuters poll predicted the ECB would leave its deposit rate at 4.00 per cent on Jan. 25. The central bank will cut rates in the second quarter, said 59 of 85 economists in the poll. Three saw a cut happening in March.

More than 70 per cent of respondents in the latest poll called for rate cuts before July compared to around 57 per cent who said the same thing in a December poll. As recently as November, 55 per cent expected no easing until at least the second half of the year. A significant minority in the latest survey, 38 of 85, said the first ECB cut would come in June. Twenty-one said April, and 23 predicted it would occur in the third quarter and beyond that period.

More than 60 per cent of respondents who answered a separate question - 27 of 43 - said the first cut was more likely to come earlier than they expected. The remaining 16 said later. "If you're hearing the ones (policymakers) that are the most talkative out there, which are the hawks ... almost all of them have been pushing against the possibility of an ECB rate cut at least in the coming months," said Jennifer Lee, senior economist at BMO Capital Markets. "But stranger things have happened, so I wouldn't be surprised if they do an earlier rate cut. Our view is still that they're going to go in June, so we'll stick to that in the meantime."

The median expectation was for 100 basis points of cuts this year, taking the ECB's deposit rate to 3.00 per cent by the end of 2024. While 36 of 85 economists forecast the rate would be higher than that, 27 predicted a lower level. When asked what was more likely on the magnitude of ECB rate cuts this year, 25 of 42 said bigger than they expected. The rest said smaller than they expected.
Headline inflation, at 2.9 per cent in December, will fall to the central bank's 2 per cent mandate in the second half of this year, the survey showed.

Upside risks, however, remain as ECB President Christine Lagarde said the central bank is on track to get inflation back to its 2 per cent target, but that the battle has not yet been won. Sixty-eight per cent of economists, 26 of 38, who answered a separate question said the risk of a significant resurgence in euro zone inflation over the coming six months was low, with 12 saying it was high. "A significant resurgence in inflation is conceivable only in case of new supply shocks. The more important risk is inflation turns out to be more sticky than expected, especially due to wage pressures," said Kristian Toedtmann, senior economist at DekaBank.

The 20-country eurozone was predicted to have entered a winter recession after it shrank 0.1 per cent in the third quarter and was expected to have contracted at the same rate in the fourth quarter. It would still be a shallow recession, as even the most pessimistic forecast pegs the economy to have contracted just 0.3 per cent in the fourth quarter. The German economy, which is Europe's largest, shrank in 2023 but still dodged a recession. It was expected to grow 0.3 per cent this year and 1.2 per cent in 2025, the latest poll showed, slower than predicted three months ago.