Inflation slightly higher in May, growth outcome and prospects improved somewhat- The ECB is very likely to cut rates this Thursday, but will make no further promises, except to be data dependant
Headline inflation increased to 2.6% in May and was slightly higher than economists expected. Services inflation increased to 4.1%, the highest level since October last year. Negotiate wage growth also accelerated in the first quarter to 4.7%, but wage growth in advertised postings still point to moderating growth in labour costs later this year. ECB staff will revise macroeconomic projections, but large revisions are unlikely – GDP forecast may be revised slightly upwards, but inflation still seems to be on track to fall to 2% later this year.
Nevertheless, this somewhat stickier inflation and wages is likely to lead to a hawkish cut this week. We expect the ECB to cut base interest rates by 25 basis points but provide little forward guidance, other than to remain data dependent. After most recent data markets expect the ECB to cut rates only 2 times this year and another 2 times in 2025. This large shift in market expectations was partly affected by higher than expected inflation in US and the perception that the ECB cannot cut too much if the Fed stays put. Nevertheless, some divergence in rates is likely and even welcome this time around, given structurally weaker growth and less expansionary fiscal stance in euro area. We maintain our view that more cuts are likely than currently are priced in by the markets but will review our forecast after the Governing Council meeting on Thursday.
