Back in December, the European Central Bank basically announced the end of the current rate hiking cycle. Financial markets took that signal and the current economic weakness as clear signs of imminent rate cuts. However, even if actual growth continues to turn out weaker than the ECB had expected every single quarter, as long as the eurozone remains in de facto stagnation mode and doesn’t slide into a more severe recession – and as long as the ECB continues to predict a return to potential growth rates one or two quarters later – there is no reason for the central bank to react. Certainly not as long as inflation remains off target.
The irony of market pricing right now is that it makes the need for actual policy rate cuts less urgent. Financing conditions have eased since early December, doing the work that actual rate cuts should do, supporting growth but also pushing up inflation risks. Consequently, the more aggressive the market prices future rate cuts, the less needed and likely those cuts will be. At the same time, given the high degree of uncertainty surrounding both the growth and inflation outlook, any more explicit forward guidance the ECB might give next week could easily become outdated by actual macro developments. Therefore, the most likely outcome of next week’s ECB meeting will be to stress data dependency and to give some insights into potential conditions for a rate cut without pre-committing to anything.