Today’s Eurozone spot CPI would end any chance of the ECB cutting interest rates by 50 basis points next month. A significant drop in expectations will be needed to push market expectations in this direction after officials failed to hold on to weaker PMIs. In France, it seems as if the worst can be avoided, but the difficult policy of reining in deficits will not disappear.
Eurozone spot CPI would end any chance of a larger 50 basis point cut by the ECB next month.
The Spanish and German CPI came in slightly below the consensus, which means that a 50 basis point cut in December is not entirely out of the question. However, today’s Eurozone CPI will have to come in well below expectations so that markets can price a higher probability of a 50 basis point cut. At the moment, only 30 basis points are being priced.
and with ECB spokespersons not convinced of the need for a deeper cut, we don’t believe that figure will rise based on a consensus reading.
The most interesting story, in our opinion, lies in the pricing of long-term inflation. The 5-year and 5-year inflation rate fell below 2.0% this week, below the ECB’s inflation target. The last time 5-year and 5-year inflation drifted below this level was in 2014, on the eve of QE. It took until 2021 for 5-year and 5-year inflation to exceed 2% again. The move highlights that concerns about the euro zone are not only cyclical in nature, but markets are also repricing long-term economic outlook.
Inflation expectations and political pressures in France
We believe that markets underestimate long-term inflation risks, which in our view tend to the upside. Structural drivers of inflation, such as demographics, decarbonization and deglobalization, will put upward pressure in the coming years. Preparing to provide financial support in the event of severe growth headwinds would prevent a return to the low inflation environment we had in the years leading up to Covid.
France: Cautious optimism that the worst can be avoided
In France, the government succumbed to pressure from Marine Le Pen’s party. While the latter is already claiming victory, they seem to see this as an opportunity to extract more concessions while threatening to topple the government. At least there’s some movement and talk – markets have so far responded with some relief, tightening the spread between French government’s 10-year bonds and Germany’s bonds by 4 basis points to just over 80 basis points.
although this is still higher than the previous June peak. The broader measure of risk sentiment, the spread between German government 10-year bonds and swap bonds, remained at -7 basis points, indicating continued caution.
In the end, the worst-case scenario may be avoided.
but the episode highlights the political struggles to control France’s fiscal deficit. It is likely to become even more difficult if the overall background deteriorates further. After markets close today, all eyes will be on S&P and whether to opt for a review of its AA-/Stable rating for French sovereign debt. The last review only took place in May, which has already led to a downgrade from AA, ahead of the European Union elections and the subsequent early French elections.
How will a higher-than-expected Annual core CPI estimates affect the ECB’s monetary policy decisions?
A higher-than-expected core CPI estimate could have several important implications for the ECB’s monetary policy decisions:
Interest rate adjustments:
A significant rise in the core consumer price index could prompt the ECB to consider raising interest rates to combat inflation. Higher prices can help calm a hectic economy by making borrowing more expensive, thereby reducing consumer spending and investment.
Reducing asset purchases:
If inflation rises faster than expected, the ECB may accelerate its plans to scale back its asset purchase program. This would involve reducing the amount of government and corporate bonds purchased by the ECB.
which are intended to support the economy.
Future orientation changes:
The ECB may change its future guidance – communications about future monetary policy directions – if inflation expectations change. A rise in the core CPI could prompt the ECB to signal that it is ready to take action sooner than previously indicated.
Focus on price stability:
The ECB’s primary task is to maintain price stability. A higher core CPI could reinforce the importance of this task, prompting the ECB to prioritize controlling inflation over other considerations, such as economic growth.
Market reactions:
Expecting a tighter stance could trigger immediate reactions in financial markets, including a stronger euro, rising bond yields.
and stock price volatility as investors adjust their expectations for future monetary policy.
Inflation forecasts:
A higher core CPI could increase inflation expectations among consumers and businesses.
which could lead to wage negotiations and pricing strategies that drive inflation higher. The ECB may respond proactively to keep these expectations firm.
