An ECB June rate cut is expected, but what comes next?

• Investors will be paying close attention to any clues about the pace of the rate-cutting cycle once it begins.
• The recent pressure on yields provides a good opportunity to add to duration by favouring yield curve steepening strategies.

Bolstered by the downward trend in euro zone inflation, the European Central Bank (ECB) is expected to confirm a 25bp rate cut at its next meeting. President Christine Lagarde and the most hawkish members of the Governing Council have strongly suggested the cut is coming, so it has been fully anticipated by markets.?

Investor focus will be on what comes next. The start of a cycle of rate cuts after a long phase of holding rates steady will raise questions about the next steps. What is the target for the terminal rate? And how quickly will the ECB achieve it? Investors will be paying close attention to any hint of an answer to these questions, as well as to the macroeconomic forecasts that are expected to be presented.

While there is a consensus on this first rate cut, the pace of future cuts is already subject to lively debate within the Council. Inflation expectations are anchored at levels close to the ECB's target (5y in 5y swap inflation was 2.3%[1]), providing a good indication of investor confidence in the central bank's ability to respect its mandate. Council focus will be more on the precise trajectory of inflation towards the central bank's price stability target and its degree of confidence that inflation will remain at that level.

After peaking at +10.6% over one year in October 2022, the consumer price index in the euro zone stood at +2.6%[2] in May 2024. The same downward trend can be seen in core inflation: after peaking at +5.7% in March 2023, it fell back to +2.9% last May. While the fall in inflation over the recent period has been remarkable, the ECB should nevertheless continue to remain vigilant about potential second-round effects following the rise in wages (negotiated wages rose by +4.7%[3] in the euro zone in the first quarter), as well as developments in other costs, such as maritime freight, which has been impacted by the crisis in the Red Sea.

Future inflation data is likely to be volatile, and the ECB is likely to caution that it is sticking to its gradual approach to cutting rates.

This message should not have any impact on markets. Since the start of the year, markets have massively revised their rate cut expectations downwards: at the end of 2023, investors were expecting 164bp of rate cuts over the whole of 2024, compared with 62bp[4] at 30 May. We don’t anticipate any further sharp revisions in expectations. We think our expectation of two cuts of 25bp by the end of 2024 seem very reasonable but are not ruling out three 25bp cuts.

For investors, the recent pressure on yields across the curve provides a good opportunity to add to duration by favouring yield curve steepening strategies.

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[1] Bloomberg 30 May 2024

[2] Eurostat 17 May 2024

[3] ECB 23 May 2024

[4] Bloomberg 30 May 2024

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