- Inflation eased to 2.4% in February, while overall economic growth remained weak.
- The ECB is likely to provide little forward guidance and reiterate data dependence.
In February, headline inflation declined to 2.4% while core inflation eased to 2.6%, the lowest level in three years. Manufacturing PMIs have strengthened somewhat in major euro area economies but remained in a contractionary territory. There was larger divergence in services sectors, where PMIs remained above 50 on average in euro area, but declined sharply in France. With increasing purchasing power, household consumption is likely to start recover in most euro area economies this year.
This week the ECB staff will revise its macroeconomic projections, which will provide clues if the ECB is more worried about the pace of disinflation or growth risks. Currently the ECB expects GDP and consumer prices this year to grow by 1.1% and 2.1%, respectively. ECB wage tracker points to sharp slowdown, suggesting that services inflation will also ease going forward. However, energy and food prices may provide some temporary headwinds for the disinflation. We forecast that headline inflation will continue declining and will fall to 2% in the final quarter of this year (slightly later than previously expected).
Another 25-basis point cut this Thursday is almost fully priced in, making surprises unlikely this week. However, some Governing Council members have recently suggested that the ECB might need to pause rate cuts. The divisions on how quickly the ECB should reduce interest rates to 2%—a perceived neutral level—are likely to become more pronounced during upcoming meetings, posing a more challenging task for Christine Lagarde in terms of communication. Markets remain unconvinced that the ECB will need to pause soon, with nearly three full cuts priced in for the next three Governing Council meetings. We still see more downside than upside risks to growth and inflation, not least because of erratic US policy. Consequently, we maintain our forecast that the deposit rate will be cut to 1.75% in September and 1.5% by February 2026.
