ECB rate cut bets premature, markets have eased too much

FRANKFURT (Reuters) – The European Central Bank will need at least until spring before it can reassess its policy outlook and market expectations for an interest rate cut in March or April are premature, ECB policymaker Bostjan Vasle said on Monday.

The ECB left interest rates unchanged last week and guided for steady policy in coming months, even as investors piled pressure on the bank to follow the US Federal Reserve in signalling rate cuts given a string of unexpectedly benign inflation data.

But Vasle, Slovenia’s central bank governor, pushed back on market bets and even argued that financing conditions may no longer be restrictive enough, given tumbling bond yields and expectations for 150 basis points of rate cuts in 2024.

“Market expectations for interest rates cuts are premature in my view, both about the start of cuts and the totality of moves,” Vasle told Reuters.

“The market pricing has lowered the level of restriction and this recent accommodation priced into interest rates is inconsistent with the stance appropriate to return inflation to target,” said Vasle, who is considered among the more conservative members of the ECB’s rate-setting Governing Council.

Sources close to the discussion last week told Reuters that a revision of the ECB’s message before March was unlikely, making any rate cut before June difficult.

Markets now see a 50-50 chance of a rate cut in March while a cut is fully priced in by April and more than two moves are seen by June.

But Vasle argued that the ECB may need to see the back of the first quarter to even contemplate revising its stance.

“We will receive limited new data before the January meeting so it won’t be before March or April that we get more information about inflation, growth, fiscal policy, and the labour market,” Vasle said. “We will need to understand the underlying trends better, and we need the new projections, too.”

Although inflation, last at 2.4%, has likely bottomed out for now, it is seen increasing again before it can drop to 2% by the second half of 2025.

“Inflation could increase back already at the turn of the year, and then hover in a 2.5% to 3% corridor through the first half of next year,” Vasle said. “So it’s appropriate to wait and observe price growth through this period and reassess our outlook.”

Wages are also unknown as workers who lost a chunk of their real incomes to high inflation in recent years demand compensation.

However, labour markets are behaving differently than the historical norm.

Unemployment normally rises when the central bank tightens policy and growth stalls as a result. This time, the labour market remains exceptionally tight even with the bloc near recession, as firms hoard labour in preparation for a rebound.

“Most of the wage formation is going to happen in the first quarter and we need to see if workers demand extra compensation or whether firms absorb some of the wage growth via margins,” Vasle said.