Tempered expectations

Comments by Franck Dixmier , Global CIO Fixed Income at AllianzGI, ahead of the ECB meeting on 14 December

• Given the recent deceleration in inflation, we believe the European Central Bank should leave rates unchanged at its next monetary policy meeting.
• The ECB is likely to remain cautious about what happens next and stress its points of vigilance, such as wage growth and base effects tied to energy prices.
• Investors' expectations of a rate cut as early as March look premature, and thus the significant recent fall in long-term rates remains fragile. After the recent rally, a pause or even a correction is likely.

Banque de France Governor Fran?ois Villeroy de Galhau recently promised "boring" European Central Bank (ECB) meetings, alluding to a long plateau phase for rates. However, we believe the forthcoming meeting should be closely watched by investors.

The latest inflation figures published in the euro zone, and the comments by ECB members that followed them, were a real turning point for markets. Investors seem to have abandoned any prospect of future rate hikes and are instead anticipating aggressive rate cuts – market pricing now implies 150bp of cuts across 2024 with the first cut coming in March.[1]

The deceleration in inflation has taken investors by surprise. Total inflation in November was 2.4%, the lowest since July 2021 and down from 2.9% in October.[2] Core inflation was 3.6% versus 4.3% the previous month, a fall reflected in both goods (2.9% down from 3.5%) and services (4% down from 4.6%).[3] What's more, this fall was shared across the whole of the euro zone, validating a true fall in inflationary pressures.

Against this backdrop, the ECB's forecast update is eagerly awaited, with a likely downward revision to the outlook for growth and inflation.

Nonetheless, in line with recent comments, we believe the ECB should adopt a cautious stance in the face of market hype and stress its points of vigilance:

• As mentioned recently by Isabelle Schnabel, member of the ECB Governing Council, wage growth remains strong (4.69% in Q3[4] ) in a context of negative productivity gains, which should continue to fuel underlying inflation;
• In addition, the end of base effects linked mainly to energy prices should justify a pick-up in inflation in the first part of 2024.

We believe the ECB must emphasise more than ever that the course of its monetary policy will remain highly data-dependent, and that it will need greater certainty about the trajectory of underlying inflation before considering rate cuts.

The ECB should temper investor expectations. Expectations of a rate cut as early as March seem premature to us, and therefore the significant recent fall in long-term rates looks fragile. After the recent rally, a pause or even a correction is likely.

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[1] Bloomberg, 8 December 2023

[2] Eurostat, 30 November 2023

[3] Eurostat, 30 November 2023

[4] ECB negotiated wage indicator, 21 November 2023 https://data.ecb.europa.eu/data/data-categories/prices-macroeconomic-and-sectoral-statistics/other-prices-and-costs/labour-costs/negotiated-wages

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[AM 3273548]

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