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The European Central Bank Set to Cut Growth and Inflation Forecasts

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Analysts predict that the European Central Bank (ECB) will leave its interest rates unchanged at its upcoming meeting in Frankfurt this Thursday. Although the ECB has made progress in combatting inflation, it will likely wait for further evidence of a drop in inflation before making any changes.

The meeting is anticipated to see a reduction in the ECB’s growth and inflation forecasts for the European Union’s economy, signaling that its policies have begun to take effect amid the strain of high borrowing costs.

According to Morgan Stanley’s analysts, the ECB is expected to revise its GDP growth guidance for 2023 from 0.7% (as stated in its September meeting) to 0.5%. Additionally, the bank forecasts a revision of its 2024 guidance from 1.0% to 0.8%, with no changes to its 2025 forecasts.

In terms of inflation, the ECB plans to lower its forecast for this year by a tenth to 5.5%, and for next year to 2.9% from 3.3%.

Despite positive signals, the central bank is cautious and will likely maintain unchanged interest rates. This is due to concerns that the recent decline in inflation may be transitory and driven by slumps in crude oil and natural gas prices. With wage inflation still high, central banks are reluctant to signal an “all clear” too soon.

Consequently, the ECB will keep interest rates on bank deposits stable at 4%, maintaining the record highs set in September after a series of 10 consecutive hikes.

“Despite all the good news on the inflation front, the ECB is likely to remain cautious,” says Michael Hewson at CMC Markets.

Instead, the ECB will likely start indicating that interest rates have reached their peak, trying to manage expectations and temper enthusiasm surrounding the possibility of interest rate reductions.

ECB Official Cautious About Interest Rate Decrease

In a recent interview with Reuters, Isabel Schnabel, a member of the executive board of the European Central Bank (ECB), expressed the ECB’s reluctance to lower interest rates too quickly. Schnabel emphasized the need for caution, stating, “Despite these positive developments, I still believe that we must not declare victory over inflation prematurely.”

As one of the influential voices in the Conservative camp of the ECB, Schnabel also dismissed the possibility of further rate increases, saying that they’re “rather unlikely.” Market data from investment bank Nomura suggests that financial markets are now anticipating approximately 135 basis points worth of cuts in 2024, with an additional 40 basis points of reductions in 2025.

Analysts suggest that the ECB will wait for clear confirmation that wage inflation has begun to decline before implementing rate cuts. ECB President Christine Lagarde echoed this sentiment during a press conference in October when she stated that the central bank is committed to achieving its 2% inflation target and will continue to take a data-dependent approach.

Citi analysts, led by Arnaud Marès, expect that rate cuts will only be implemented when staff inflation forecasts show a significant drop below 2%. This cautious approach aims to prevent the ECB from acting prematurely. Nomura analysts, led by Andrzej Szczepaniak, now predict that the ECB will start cutting interest rates in June 2024, with their previous forecast suggesting a September rate decrease.

The earlier-than-expected interest rate cuts are projected to pave the way for a series of substantial reductions. Analysts argue that the ECB’s cautious approach will provide ample room for rate cuts. Morgan Stanley’s analysts anticipate two 25 basis point cuts in June and September 2024, followed by more pronounced 50 basis point cuts in December 2024 and March 2025.

Amidst all of this, experts also suggest that the U.S. Federal Reserve and the Bank of England will adopt similarly cautious approaches, refraining from making explicit promises regarding interest rate cuts.

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