As widely expected, the ECB cut its key policy rates by 25bp on 12 December, lowering the deposit rate to 3%. The reference to the need to keep policy ‘sufficiently restrictive’ was dropped from the monetary policy decisions press release where central bankers described the disinflation process as ‘well on track’.
During her press conference, ECB President Christine Lagarde stressed it was not ‘mission accomplished’ yet in the fight against inflation, but developments were on the right track. There is a subtle change in the ECB’s objective, which is now ‘to ensure that inflation stabilises sustainably at its 2% medium-term target’. Previously, it was determined that inflation return to target in a timely manner’.
September’s ECB staff macroeconomic were updated (see Exhibit 1): they now anticipate lower growth and lower inflation, while wage growth is projected to continue its sustained decline, moderating from an average of 4.6% in 2024 to stand at 2.8% in 2027.
At the same time, the ECB acknowledged that ‘labour markets are still tight, which helps to explain why wage growth remains elevated compared with the historical average level of 2.3%’.
The ECB says policy decisions are ‘data dependent’, but again it appears its projections are playing a part in decisions. Ms Lagarde pointed out that “inflation in our projections has converged towards 2% for six projection exercises in a row… In 2025, we shall be at 2%”. According to several ECB policymakers, such a high level of confidence should have resulted in a rate cut by more than 25bp.
Why not 50bp?
Ms Lagarde said “there were some discussions around a 50bp cut’ during the meeting, but all members agreed 25bp was appropriate. However, sources said after the meeting that ‘around five’ central bank governors favoured a 50bp cut, arguing GDP growth expectations were overdone given all the headwinds that could arise next year, including the unknowns around US trade policy.
Doves have been making themselves heard recently and some governors that were seen as neither doves nor hawks now lean to the dovish side.
One example is in a speech by the Banque de France Governor at the end of November. Commenting on the size of a cut in December and ‘back-to-back’ cuts in each of the following meetings, he said ‘we should stick […] to what I call an “agile pragmatism”, data driven, but not timid’.
Neutral rate in sight?
Mrs Lagarde said the governing council did not discuss the neutral rate and referred to an ECB publication early this year that pointed out the uncertainties around setting the neutral rate and its use as an indicator for monetary policy. She mentioned the neutral rate was probably a little higher now and, that, at some point, the ECB would have to start to discuss when to stop cutting rates.
Nevertheless, Ms Lagarde confirmed that even if financing conditions are easing, they continue to be tight because monetary policy remains restrictive. Asked about the degree of restrictiveness, she said that she would give a speech on 16 December at the Central Bank of Lithuania Annual Economics Conference ‘dissecting in great details’ on how restrictive the monetary policy is and ‘a sort of direction forward’. A promising trailer!
In this cycle’s journey towards the neutral rate, it appears that ECB doves are more likely than hawks to make life difficult for the ECB president – at least in the short run.
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