As far as the European Central Bank is concerned, today’s German inflation data will catch the hawks’ attention, as it bolsters the argument for a high bar to yet another ECB rate cut.
More generally speaking, when the ECB returned from its summer break, several more favourable developments had strengthened its wait-and-see stance, at least at first glance: the ‘it-could-have-been-worse’ trade agreement between the US and the EU, a weak-but-not-disastrous second quarter GDP growth reading, as well as still improving business sentiment indicators which have rather strengthened than weakened the case for staying on hold at the September meeting.
However, we think that it is still too early to rule out a September cut. Why? First of all, the ECB doves have been very silent since the end of the summer break, and it has been the traditional ECB hawks trying to shape the policy debate. Also, there is a growing awareness among eurozone policymakers in general that the trade framework agreement between the US and the EU is anything but set in stone. The built-in conditionality on many aspects has left sufficient room for new escalations.
And, finally, there is a handful of arguments that a too-hawkish stance could eventually backfire and increase the risk of inflation undershooting. As ECB staff are currently also preparing a fresh round of macro projections for the September meeting, the euro has gained another 2% since the June projections, bond yields are up by some 30bp and French public finances are back on markets’ radar screens. And even if the central bank fiercely disputes that it reacts to monetary policy in other countries, a Federal Reserve starting an aggressive series of rate cuts would only add to the risks of inflation undershooting.
All in all – and even if it might be counterintuitive given the resilience of the eurozone economy – we still wouldn’t rule out another insurance rate cut, following the principle that it wouldn’t do any harm but could eventually do good. Admittedly, though, today’s German inflation data has not strengthened the case for a rate cut in September.