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Inflation Uptick Raises Questions about Expected ECB Rate Cut

Updated: Jun 11

By Nico Herrlett

All attention is on the European Central Bank (ECB) as unexpectedly hot inflation data spreads uncertainty surrounding its long-awaited policy meeting on June 6. A rebounding Eurozone economy, sticky services inflation and stronger-than-expected wage growth will likely spark fierce debate among hawks and doves within the ECB’s Governing Council.

While markets expect the ECB to hold on to the widely anticipated 25 basis-point cut, the recent flare-up in inflation clouds the Eurozone’s monetary policy trajectory beyond the meeting on Thursday. Seen by some as a bump in the road of a downward inflation trend towards the 2% target, financial markets will observe the upcoming meeting closely for hints and currently price in 2 further cuts for this year.

Alongside the risk of unmaking gains in the ECB’s long-fought battle against inflation, macroeconomic uncertainty remains high, with mounting geopolitical tensions in the Middle East as well as upcoming elections in the EU and across the Atlantic. Governing council member Fabio Panetta emphasises the importance of prioritising careful policy action in this volatile environment.

After the Federal Reserve’s (FED) favourite inflation gauge finally showed cooled price levels, Fed Chair Jerome Powell reaffirmed that the next move will be a cut, not another hike. The US-Dollar weakened in May for the first time this year, after high interest rate differentials had driven a wedge between the US and other Western economies. Nonetheless, US policymakers are split on the timing of the upcoming cut and will wait for growth forecasts and labour market data later in June.

The US economy proved stronger than expected in Q2 but is visibly pressured by the FED’s higher-for-longer policy stance, clouding consumption outlooks. With food and energy price levels still up by 25% since 2021, US consumer sentiment appears decoupled from actual activity levels. While inflation levels, i.e., the change of price levels, have cooled, food and energy price levels hurt the US public the most and put significant electoral pressure on the Biden administration.

Low US sentiment levels may also turn out to be a major pain point for the Chinese economy, whose export orders faced a substantial slowdown in May. Just last week, the International Monetary Fund revised its China growth forecasts for this year slightly upward to 5 percent in response to support schemes for China’s slumping property sector.

In May, the Chinese administration announced that 300 billion yuan of central bank funding would be channelled to buy excess property and transform it into low-income housing. However, the Chinese economy gives off mixed signals, as the official purchasing manager index showed a surprise fall in factory activity on Friday, which was then contrasted by a more optimistic reading today. While a Chinese rate cut is only expected in later quarters, the People’s Bank of China may free up investment by cutting reserve requirement ratios for its banks. Beijing’s policymakers face continuous pressure as the Chinese economy battles with US trade restrictions, mass protests and youth unemployment at an all-time high. 

Market report published on 3 June 2024.

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