ECB meeting comes and goes with no change but Lagarde still has questions to answer

Expectations for any change in policy going into the January meeting of the European Central Bank’s (ECB) Governing Council were exceptionally low.

In the absence of new ECB staff forecasts for key metrics on growth and inflation, the logical expectations were for no change, either in policy itself or the wording around policy stance. In the days and weeks going into this meeting, incoming data was mixed; inflation appeared to be a continuing downward trend in many jurisdictions, but labour market data remained strong and sentiment indicators were generally more positive than consensus market expectations. Around the turn of the year, the market was pricing an aggressive rate cutting cycle from the ECB, starting as early as March 2024 and entailing as many as six 0.25% cuts over the course of the 2024. This reflected the market view that the ECB would be forced into easing policy as a result of declining economic activity and a possible Europe-wide recession.

However, in the run up to Thursday’s meeting, and ahead of the mandatory black out period, it was the ECB hawks who were most vocal, pushing back on market pricing and suggesting that rate cuts were a topic for the second half of the year, stressing that they need to ensure that inflation has firmly returned to target before any easing could take place. The market reacted by pushing out its first cut towards the middle of 2024 but followed by a series of deeper cuts as it felt that by waiting until June, the ECB may be too late and have to ease further to provide greater stimulus to an ailing economy.

So, the focus for this meeting was not so much on changes to monetary policy, but on what ECB President Christine Lagarde would have to say in the accompanying press conference. Would President Lagarde push back on market pricing of rate cuts, what were the key data points and levels that they were monitoring in order to maintain or change policy and when could the market reasonably expect policy to start easing? And, crucially, would the market believe her?

At the meeting, policy was unchanged as expected by the market, and journalists were even told to ignore any small changes in the wording of the policy statement, but this didn’t stop government bond markets rallying following the announcements. Why was this? A key driver appeared to be the unwillingness of President Lagarde in the accompanying press conference to rule out a rate cut in early spring. This was despite emphasising the importance of incoming labour market data, and wage settlements in particular, which would not be available until later in the spring.

In trying to keep all options open in order to preserve maximum flexibility, the market seized on this as a dovish indicator, assigning a probability of close to 90% that the ECB would embark on a loosening cycle as early as April. Lagarde pointed towards the availability of two more months of inflation data by the time April comes around, possibly opening the door to a cut, if this data shows a sustained return to their 2.0% target. However, the emphasis was very much skewed towards incoming wage settlements and it seems that the ECB’s base case would be for the loosening to begin in June, when they would have access to far more data. Notwithstanding this, they kept the door open to acting sooner, should it be warranted.

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