3 things to watch for at next week’s ECB meeting

Carsten Brzeski

With inflation falling further and the euro zone economy weak, talk of interest rate cuts will be more heated than ever at the ECB meeting on March 7. But stubborn underlying inflation, especially services inflation, uncertainty about wage changes and never-ending inflation. Confidence in the euro zone’s economic rebound will likely prevent the ECB from cutting interest rates, at least not when it meets next week. As long as the ECB refuses to accept that inflation is returning to roughly target levels and instead pushes for a precise 2% landing point, rate cuts should only be on the agenda at its June meeting. This is when enough data points are available to confirm that the beast of inflation has indeed been tamed, or to point to new upward pressure on prices.

Needless to say, at next week’s ECB meeting everyone We will be watching for changes and hints in communication in the next steps. Here are three things worth noting:

1. New staff plan

New employee projections will support the discussion. Last December, the ECB predicted GDP growth of 0.8% this year and 1.5% next year. Inflation was expected to be 2.7% this year and 2.1% next year. More importantly, these headline figures overshadow somewhat optimistic growth forecasts for the eurozone economy to return to potential growth of 0.2% QoQ in the first quarter and 0.4% QoQ by the third quarter. The most important factor regarding inflation was the forecast for a return to 2.0% in the third quarter of 2025. Open the door to an early rate cut if the growth profile is revised downward and there are signs that inflation could reach 2% earlier than the third quarter of next year.

However, the problem with the ECB’s forecast is that the so-called technical assumptions – oil and gas prices, interest rates, exchange rates, etc. – suggest a slight downward revision of the ECB’s inflation forecast in the first week of February. Nowadays, these forecasts are automatically changed when oil prices rise again. The sensitivity of the ECB’s forecasts to market changes will likely make the central bank more hesitant to use forecasts as the sole argument for policy changes.

2. Potential changes in communication

The European Central Bank isn’t really known as a central bank that changes policy decisions quickly. Instead, next week’s meeting is likely to see another cautious and gradual shift in inflation assessments, opening the door to a rate cut in June. In recent months, the ECB’s communication on rate cuts has gradually shifted from “we haven’t even spelled ‘rate cuts'” to “it’s too early to discuss rate cuts” in January. If the bank says that members “had an initial discussion on the prerequisites for rate cuts” or “decided to begin these discussions at the next meeting,” this would signal a further change in direction of policy easing. Another way to signal an upcoming change in policy stance would be for the ECB to adjust its risk assessment to both inflation and growth forecasts. A “balanced” risk assessment of the inflation outlook would be a strong signal in favor of a rate cut.

In any case, the main challenge for the central bank and ECB President Christine Lagarde is to take back ownership of the story. Since the beginning of the year, the cacophony of central bank governors talking about the timing of future interest rate cuts has resembled a very loud atonal choir. We sometimes wonder whether central banks should really try to provide forward-looking guidance beyond their next meeting. Instead, what next week’s meeting could help with is further clarity on the central bank’s reaction function – i.e. what part of the data the ECB wants to see before deciding to cut interest rates. This will also help rationalize the very confusing and loud comments made by ECB officials.

3. More details on ECB’s reactive function

One elegant way to manipulate market expectations is to make the ECB’s reaction function more explicit. Currently, we believe that three criteria must be met before the ECB begins to cut interest rates. i) Long-term inflation forecasts (current inflation is set back at 2.0% from the third quarter of 2025) should remain unchanged. ii) Nominal wage growth should be reduced to around 4%. iii) The real inflation rate is around 3%, which means that real inflation should be at least around 2.5% for some months as the central bank fears that confidence will be damaged when it cuts interest rates. Of course, an early interest rate cut could be triggered by unexpectedly severe financial market stress or a severe recession in the Eurozone economy. Such clarity means more consensus within the steering committee.

Beyond the timing of the first rate cut, the next questions are how far and how fast the ECB will go. Here, the fact that the eurozone economy is not in recession and that inflation risks and inflation prospects are still on the rise (due to structural as well as cyclical drivers) plays an important role. Financial market participants still appear to be betting that the interest rate increases of the past two years will be simply and quickly reversed. But this kind of reversal has traditionally occurred only when the economy is in a deep recession.

Paving the way for interest rate cuts in June

Overall, even without any interest rate action, next week’s ECB meeting is expected to be a very interesting one. Recent macro data has increased pressure on the ECB to cut interest rates early. We still think the ECB has good reasons to resist that pressure and push back on its expectations. Nonetheless, subtle changes in official communications should continue to send a more accurate signal about the June rate cut.

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