PGIM Fixed Income: It’s a case of once bitten, twice shy

PGIM Fixed Income: It’s a case of once bitten, twice shy

18 januari 2024

Fed
Federal Reserve (2).png

Katharine Neiss, Chief European Economist at PGIM Fixed Income, looks ahead to the ECB's interest rate decision next week.

Despite clear signs that the euro area is weakening and inflation is falling back towards target, we expect the ECB to hold rates at their next meeting and that the prospect for cuts may be some way off.

Our reasoning is derived from ECB comments, which suggest that the Governing Council would like to see easing across a range of factors that influence underlying domestic inflationary pressure. This includes not only core and services inflation, but wages and firm markups as well. That would put Q2 as the earliest period in the frame for cuts.

Put simply, it’s a case of once bitten, twice shy and policymakers will want to be sure that the inflation genie has been put firmly back in the bottle.

In addition, to being ‘data dependent’, the ECB have said that interest rate rises in the latter part of 2023 were insurance hikes against the possibility of further eg food and energy price shocks, and the prospect of de-anchored inflation expectations.

Although food and energy prices have recently fallen back, and energy stores in Europe remain high, escalating tensions in the Middle East suggest that it may be too early to drop this insurance just now. Our base case therefore is that the ECB will cut rates in the summer, leaving rates at closer to 3% by year end.

That said, the rapid deterioration in activity at the end of last year has increased the risk that the ECB has overtightened in 2023.  Near term momentum has been on a clear downward trend for both core and services inflation, and is now at or below the level consistent with the 2% target.

In such an environment, moving later rather than sooner would exacerbate the downward pressure on inflation, risking a return to the pre-pandemic period of chronic below target inflation in the region.

In his case, we could see the ECB removing insurance sooner rather than latter, and cutting rates more aggressively than in our base case.

Gerelateerde berichten