The European Central Bank is holding rates steady once again, with the deposit rate at 4.00 percent. Geopolitical tensions and the slowdown of the global economy are worrying, as already highlighted by President Christine Lagarde during the World Economic Forum in Davos. The consequences of the escalation of the crisis in the Red Sea, with the Suez Canal completely blocked for cargo ships, are still to be assessed. Initial hypotheses speak of an impact on inflation of up to one percentage point. Better to take time, Frankfurt agrees, despite institutional investors having asked for more interventionism, therefore more cuts in the cost of money, to deal with the current crisis.
The Governing Council of the ECB has decided to wait. A decision that was in the air, especially after Lagarde’s statements in the Swiss resort. The next readings of macroeconomic data will be important. The first signs of the Red Sea crisis, with the Yemeni Houthi rebels playing havoc in the Strait of Bab-al-Mandab, attacking Western merchant ships, occurred in mid-October. Now the escalation. Which is why it is better to wait for the first data on the controversy. Konstantin Veit, portfolio manager at Pimco, on the eve of the Frankfurt decision, believed that there would be few leaps forward. “Short-term growth is expected to be weaker than expected. However, the December inflation forecast was based on the interest rate path indicated by market data as of November 23, 2023,” he explained. This data “suggested a rate cut of around 75 basis points for 2024. Financial conditions have eased significantly since then and updated projections will be released at the March meeting.” Market forecasts, according to Velt, “currently suggest around 140 basis points of rate cuts this year, starting in April, and a terminal rate close to 2% in 2025.” Due to uncertainty over the inflation outlook, Pimco says, “we doubt the ECB will implement rate cuts so soon. The ECB is likely to continue to monitor inflation closely without prematurely declaring its success.”
In terms of rates, it is noted that “the new information has substantially confirmed its previous assessment of the medium-term inflation prospects”. Aside from an energy-related upward base effect on headline inflation, “the downward trend in underlying inflation has continued and past increases in interest rates continue to feed through strongly to financing conditions.” Restrictive financing conditions “curb demand, contributing to the decline in inflation”. At the same time, “The Governing Council will continue to follow a data-driven approach in determining the appropriate level and duration of the restriction.” In particular, “interest rate decisions will be based on its assessment of the inflation outlook, given new economic and financial data, the dynamics of underlying inflation and the intensity of monetary policy transmission”. All eyes on the ongoing geopolitical tensions, therefore.
On the administration front of the budget reduction, progress is as expected. The Board, reports the ECB, “intends to continue to reinvest, in full, the capital reimbursed on maturing securities under the PEPP (Pandemic emergency purchase programme) in the first part of 2024”. In the second part of the year, however, it intends to “reduce the PEPP portfolio by 7.5 billion euros per month, on average, and end reinvestments under this program at the end of 2024”. The possible unknowns are those linked to the ongoing wars, from Ukraine to the Middle East via the Red Sea and the skirmishes between Iran and Pakistan. All elements that could fuel inflation in the Mediterranean Sea.
A concept which is what Lagarde explained to political decision-makers in Davos. Not without having repercussions on the intrinsic credibility of his figure. Managing this crisis will not be an easy task. It is possible that, in the wake of market rumors, a cut will be made at the beginning of the summer. We are talking about June with ever greater insistence. But the Red Sea trouble, if it were more serious and lasting than expected, could change the cards on the table.