The ECB President delivered a rather hawkish stance in her latest press conference, diverging from the Fed’s signals and pushing back against market expectations on interest rate cuts.

The European Central Bank held its key interest rates steady in its final meeting of the year, signaling a steadfast commitment to a data-dependent approach and a keen watch on economic indicators, aiming for a timely return to the 2% inflation target.

Frankfurt also announced its plans to initiate the sale of government bond securities acquired under the Pandemic Emergency Purchase Programme (PEPP) starting in the second half of 2024, at a rate of €7.5 billion per month.

During her press conference, Lagarde stressed that past increases in interest rates have wielded considerable influence over the economy.

However, while Powell’s comments have opened the door to potential rate cuts, Lagarde has firmly distanced the ECB from such considerations, maintaining a course aimed at guiding inflation back to the desired threshold of 2%.

The latest ECB economic projects revealed that headline inflation is expected to to average 5.4% in 2023, 2.7% in 2024, 2.1% in 2025 and 1.9% in 2026. Compared to the earlier September forecasts, there were downward revisions for both 2023 and 2024.

A message for the markets

“We should absolutely not lower our guard,” Lagarde asserted, dispelling any speculation about an imminent softening of the ECB’s monetary policy.

Despite market players betting on potential rate cuts mirroring the Fed’s direction, Lagarde clarified that the ECB’s policy decisions are data-dependent and not influenced by market pricing or time-bound pressures.

Amid worries about a potential economic downturn and its ramifications, Lagarde’s remarks conveyed a less concerned stance, highlighting the labor market’s robustness, with unemployment maintaining low levels, and the expectation that rising real incomes—bolstered by the receding energy crisis and the rollback of fiscal measures—will underpin economic recovery.

“Euro area banks have demonstrated their resilience,” Lagarde commended, citing improved capital ratios and profitability over the past year.

The latest ECB staff projections are cautiously optimistic, indicating a slight uptick in economic growth from 0.6% in 2023 to 0.8% for 2024, advancing to 1.5% for 2025 and 2026.

…and a message for Brussels

Lagarde stressed the necessity for eurozone countries to roll back the fiscal support measures implemented during the energy crisis. As energy prices stabilise, these measures, particularly the discretionary fiscal support to offset high energy prices, “are becoming less justified and justifiable”.

Additionally, Lagarde addressed the necessity for eurozone nations to enact fiscal policies that bolster productivity and mitigate high public debt. She also delivered a pointed message to European policymakers in Brussels, underscoring the urgency to overcome procrastination and technical delays in vital reforms imperative for the eurozone’s economic fortitude and competitiveness.

“It is crucial to swiftly agree on the reform of the EU’s economic governance framework,” stated the ECB President, signaling the importance of decisive action for fiscal and structural reform.

Market reaction to Lagarde’s comments

In the forex market, the euro made gains, reaching 1.10 against the dollar following Lagarde’s comments.

Conversely, European stocks saw a downturn, with the Euro STOXX 50 dropping 0.9%, and Germany’s DAX index declining by 1.1%.

Italy and France’s major equity indices experienced lesser setbacks, and Spain’s IBEX 35 curtailed its ascent.

Despite the ECB’s clear message, money markets are still betting on 155 basis points of rate cuts by the ECB in 2024, translating to six cuts of 25 basis points each.

This disconnect sets a stage of anticipation and speculation, leaving observers to wonder between the ECB’s steadfastness and market predictions, which will ultimately reflect the economic reality.