Next week’s European Central Bank meeting is more important than it might first appear. President Christine Lagarde needs to set the template for 2025, and the clarity of her message is paramount: Forward guidance that the restrictive monetary policy period is over and avoiding recession is the priority.
The Governing Council is widely expected on Dec. 12 to deliver a 25 basis point cut, resisting a more aggressive 50 basis point move. It's just not the ECB's style to surprise — it’s a committee representing 20 nations after all — and the euro money markets aren’t expecting it. There’s also the fragile state of the euro which is hovering precariously above parity to the dollar.
This is an ECB quarterly economic review — with updated growth and inflation forecasts — most of which are likely to be lowered. The biggest bugbear for hawkish policymakers has been sticky service sector inflation, but the November euro area CPI data showed appreciable softness. The euro five-year forward inflation swap, former President Mario Draghi's favorite indicator, has fallen below the ECB's 2% target. Inflationary expectations are freezing as winter comes.
The window for a more leisurely quarterly interest-rate reduction pace has slammed shut. Lowering rates at consecutive meetings, until monetary policy is no longer restrictive, is now the safest route. It's imperative to prevent the nightmare scenario of being forced to cut them savagely — potentially even below zero again — if the economy craters.
Most estimates of the euro area neutral rate center around 2%. It would be smarter to head for that with some haste and then assess conditions at a point where employment and inflation might be more in balance. Recessions can slide into deflationary traps, something the euro area spent the 2010s trying to escape from.
It wouldn't be an important turning point for the ECB though without some dissent. That's come most significantly from Executive Board Member Isabel Schnabel of Germany, who sees only limited room for easing. This is a sign of the internal battle and should be politely ignored amid the clamor of policymakers calling for interest rates to be cut faster. Among the more vocal doves has been influential Bank of France Governor Francois Villeroy de Galhau, who has been pushing for continued easing.
In concert with a speech from Lagarde, Villeroy made an important address on Nov. 22 with German Bundesbank head Joachim Nagel at the Bank for International Settlements. It was a rare step for central bank heads to call for substantive action from euro area governments and the European Union to get their fiscal act together, as well making substantial steps to complete banking and capital markets union. The ECB is fully aware that monetary easing alone will be woefully insufficient to counter any serious economic downturn.
With France's domestic political strife, amid concomitant budgetary pressures, there's no doubt lowering the overall euro area interest-rate bill would be welcome. But this would have limited immediate effect. A fiscal bazooka is needed. November French purchasing managers survey fell to match Germany's parlous low at 43.1, which is deep into contraction. Italy is also at its lowest for a year.
But perhaps the incontrovertible evidence that something is seriously awry is when it starts impacting the neighbors. UK November composite purchasing managers survey showed a slump to 48 from 49.9 in October, with several business lobby groups citing falling orders from the euro area. Swiss National Bank Martin Schlegel put it succinctly on Saturday at a Bundesbank event in Frankfurt, “When Germany has a cold, Switzerland has the flu.”
Bank of America Corp. analysts won the early bird prize last week by boldly calling for a contrarian bullish bet on European equities. How early a call that proves to be rests on how much fiscal stimulus next year emanates from both individual nations — we’re looking at you, Germany — as well as coordinated from the center by the European Commission. The ECB can provide sprinkles of monetary love to boost the combined effect. But a shortage of both will make for some tough chewing next year. Getting the ECB deposit rate down to near 2% ought to be a no-brainer. The time for that plan to be put into place is on Dec. 12 at the ECB towers in Frankfurt.
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