ECB: change of key rates ante portas

01 What happened?

As almost unanimously expected, the ECB left key interest rates unchanged at its meeting. On the one hand, this was to be expected because no new ECB staff projections regarding inflation or economic developments were on the agenda today. This will not happen until the next meeting on June 6.

On the other hand, at the press conference following the March meeting and in interviews in recent weeks, ECB President Lagarde pointed out that the ECB needed a lot more information to be sufficiently confident that inflation would return to the 2% target. She stressed on several occasions that “some more" would be known in April, but “a lot more" in June.

Some supporters of monetary policy tightening on the ECB's Governing Council, such as the central bank governors of Germany and Austria, recently signalled that interest rates could probably be cut in June. The latest inflation data (March: headline 2.4% and core 2.9%, both data points slightly lower than analysts had forecast) further fuelled expectations of a pivot on interest rates.

In today’s statement, the ECB issued its first explicit indication that an interest-rate reversal is likely to happen, mentioning that, under certain circumstances, "reducing the current level of monetary policy restriction would be appropriate."

Christine Lagarde also stressed in the press conference that "the risks to economic growth remain tilted to the downside." According to Lagarde, some members of the Council were in favour of an immediate cut in interest rates. But she repeated her stance: "In June we will get a lot more data and a lot more information and we will get new projections." Labour market shortages are expected to decline gradually, and inflation is expected to fluctuate around current levels in the coming months and to then decline.

02 How did markets react?

The outcome of the ECB meeting was exactly in line with the expectations of the financial markets and therefore there was no strong market reaction. In the swap markets, the potential magnitude of the ECB's interest-rate cuts in 2024 was barely changed after the statement was published. Overnight Index Swaps are pricing around 75 basis points in interest rate cuts, i.e. three 25 basis point cuts, by December 2024. Yields on two- and ten-year Eurozone government bonds rose slightly, but the EUR depreciated moderately against the USD. The Euro Stoxx 50 declined about 1% after the opening of the U.S. stock exchanges.

03 What does it mean for investors?

In principle, the ECB has delivered exactly what financial markets expected in the run-up:

With the publication of its new staff projections at the June meeting, the ECB should be able to sufficiently justify a first interest rate cut, unless inflation rises unexpectedly in April or May. This is not to be ruled out, with the rate of services inflation remaining too high at 4.0% to date. Wages are also rising faster than the historical average. This could keep the inflation rate higher than targeted, owing to possible increases of consumption spending as a result of rising real wages, as well as the recent appreciable rise in prices of some commodities. The ECB will therefore carefully address monetary easing.

A possible divergence between the ECB's monetary policy and that of the Fed could also play a role. After higher-than- expected March inflation in the U.S., interest-rate futures markets have postponed the timing of a first rate cut by the Fed into the fall. The ECB could seek to avoid letting the interest- rate and yield gap between the two currency blocs become too large. Indeed, a possible depreciation of the EUR could generate upward pressure on the inflation rate by increasing import prices.

This ECB meeting delivered nothing unexpected – a June interest-rate turnaround seems almost certain. The higher- than-expected March inflation data from the U.S. continue to have a greater relevance for market prices. These continue to generate rising returns and strong tailwinds for the U.S. dollar. The ECB will not be able to ignore the Fed's continued restrictive monetary policy, and thus is likely to ease its own monetary policy very gently. Government bond yields therefore have only moderate downside potential. Stock markets could focus their short-term attention on the unfolding of U.S. indices and the coming reporting season.