Christine Lagarde, President of the European Central Bank (ECB).
Bloomberg | Bloomberg | Getty Images
FRANKFURT – The European Central Bank is meeting this week with investors watching closely to see when the Frankfurt institution could start cutting rates.
It will still be too early to declare victory in the fight against inflation, but with inflation at its lowest level in two years, this certainly gives the ECB Governing Council breathing space to focus on another important issue: the gigantic balance sheet.
“Having reached its policy interest rate plateau of a 4% deposit rate, the ECB can now shrink its balance sheet at a faster pace without running the risk of yield spreads within the eurozone widening too much,” says Holger Schmieding of Berenberg in an investigation. note for customers.
“Nevertheless, markets will likely have to adjust some of their overly optimistic interest rate cut expectations once the ECB speaks on Thursday.”
Inflation plummets
Inflation fell to 2.4% in November and core inflation also fell. With inflation falling faster than expected, investors have raised their expectations for ECB rate cuts next year, especially after one of the more hawkish board members, Isabel Schnabel, called the slowdown in consumer prices “remarkable” and “a pleasant surprise.” to a transcript of a December 1 interview with Reuters.
![Moody's expects the ECB and the Fed to cut interest rates by mid-2024](https://image.cnbcfm.com/api/v1/image/107344976-17020263081702026306-32361267374-1080pnbcnews.jpg?v=1702026307&w=750&h=422&vtcrop=y)
Money markets are currently pricing in almost 150 basis points of interest rate cuts for next year. The bank’s key deposit rate is at a record high of 4%, after ten consecutive hikes that started in July 2022 and pushed rates back into positive territory for the first time since 2011.
“The risk now is earlier and bigger cuts, and an ECB that is better able to decouple from the Fed,” said Mark Wall, ECB watcher at Deutsche Bank.
But he believes the ECB will most likely keep its cards close to its chest: “We expect the ECB to maintain the guidance that maintaining restrictive interest rates for a sufficient period of time will bring inflation back to target in a timely manner.”
PEPP rollout
Looking ahead, a new round of staff projections for inflation and economic growth will take place in March, which will give the central bank more data to support its data-dependent policy approach and potentially give room for rate cuts.
But this week, the most significant policy change at the end of Thursday’s ECB meeting could take the form of a shift in forward guidance – particularly when reinvestments from its PEPP program are due to end.
The PEPP, or Pandemic Emergency Purchase Program, is a flexible bond purchase program introduced during the coronavirus pandemic. The ECB is reinvesting all maturing securities it withdraws from its PEPP portfolio, but that could soon change.
![The Allianz economist explains why the ECB cuts will only take place at the end of 2024](https://image.cnbcfm.com/api/v1/image/107341802-17014324461701432443-32262012768-1080pnbcnews.jpg?v=1701432446&w=750&h=422&vtcrop=y)
“We have indicated that we would continue to reinvest until at least 2024,” ECB President Christine Lagarde told European Parliament lawmakers on November 27.
“This is an issue that will likely come up for discussion and consideration within the Board of Directors in the not too distant future, and we may re-examine this proposal.”
Deutsche Bank’s Wall explained that “if rate cuts continue, the ECB could accelerate the preliminary steps in phasing out PEPP reinvestments.”