So there are the countries where inflation is actually running really low, like for example France, we had the recent reading of 0.4. Also Italy has a much too low inflation to the liking of the ECB, and of course those countries would prefer a rate cut, whereas others don't. So I guess the key question is how inflation will move forward from now and how this euro-dollar exchange rate will develop, because clearly the higher the euro, the less inflation is getting imported into the euro area, and that's already felt in the latest inflation figures. We just got, I think yesterday, a reading of 1.7%. And of course, if that drops even further, then the ECB might want to act with a rate cut. Currently, if you look at market expectations, interestingly, it's still the majority of ECB watchers who think that the next rate move will actually be a rate hike, given that the economic picture is actually rosier than expected. So, in a way, two forces are working on that inflationary trend. On the downside it's the high euro or the low dollar, as you like, and on the other side is the economy which does a lot better than expected. Proof is for example just the industrial orders from Germany who jumped a second month in a row, and everybody is already saying now the stimulus is finally there because those orders were actually triggered mainly or pushed mainly by the defense industry and also infrastructure spending. So you see that economic picture might actually move in the biggest economy of the euro area.
Aneta, there is a question I wanted to ask you about the strength that we're seeing in euro. Some of this has been a consequence of the weakness in the US dollar. And there are questions whether Trump wants a weaker dollar, but there are also questions as to whether Europe wants a stronger euro to play in the world economy, whether this is sort of signaling some sort of geopolitical strength, having a stronger currency. Do you want to just weigh in on that? Because I know the central bankers are looking at strength in the euro.
It's an interesting one because I think on the one side everyone wants to have a global Europe, a strong currency, but nobody really wants to have the downside effect on their economy. So, yes, the ECB, I think, would love to see a stronger euro or a global euro being much more of a reserve currency, more influential and important in financial markets. But at the same time, you can't have it all. You also have then to probably live with a stronger external value of the euro which we are now potentially witnessing if it's not the other side of the coin, just a very prolonged weak US dollar. Currently, there are apparently also plans in the making that the ECB is weighing in with Brussels to think about swap lines which then could be guaranteed by the ECB in case there will be a wider financial crisis once again, because there's a concern also raised by the German financial watchdog BaFin when I went to their press conference last week that there is a concern that if the Fed actually gets less independent with the new Fed chair, they also could use the swap lines, the US dollar swap lines as a political instrument. And of course, nobody wants that. Everybody wants to have a safe and sound financial system. And I guess all that plays into the mix, but one thing is a prerequisite for a global euro. That's a capital market union which actually is really intact.
Aneta, great setup and I've got to say, you are certainly gaining versus sterling today on the back of a dovish hold from the Bank of England and the politics of the day here domestically. Let's get to Lorenzo Codogno who is founder and chief economist, Lorenzo Codogno Macro Advisory. Lorenzo, thank you so much for joining us again. I know you're looking at a couple of moving pieces here around the ECB and what it could do for the rest of this year. One of them too is the strength in euro. We had that big adjustment last year. The governing council members were looking at it as a one-off adjustment, but there are still dangling questions this year as to whether the strength we've seen in recent weeks could continue and whether that would warrant more than a one-off adjustment. What do you think as we talk about the interest rate here for Europe and whether euro could be a major factor in 2026?
My view is that the ECB will keep rates on hold for as far as the eye can see. So I think there is no change in policy in the pipeline. Nevertheless, as you mentioned, there is probably some downside risk in the near term. Should the dollar continue to depreciate and the euro strengthen, or should the independence of the Fed be threatened, or perception in financial markets be such that the financial markets build up some kind of inflation premium in the US, which inevitably would translate into tighter monetary conditions in the euro zone as well. So I think this might be something that is to be watched over the coming weeks and months, but so far I think the movement has been moderate and certainly not enough to change the stance of the ECB. So I think the ECB will continue to send a message suggesting that there is no change in sight and that the bar is pretty high for any change in policy at this stage.
Lorenzo, to the point around the impact of any further strengthening in euro with the inflation stability picture. It feels as though some of the room has dissipated from here because the inflation print we just got, 1.7% for the euro zone, slipping off the 1.9% handle a prior month in December, suggests we're getting lower and lower under that 2% threshold. What happens from here? Is there a stability problem to the downside because of some of that strength in euro?
I wouldn't read too much into the 1.7% inflation print that we got recently because if we look at the composition, it was mainly a base effect related to energy. There is some easing in underlying inflation but a very modest one, and I think once the energy base effect is out of the way, which means in two months' time, probably the situation will stabilize. So again, unless you see some significant weakening in components of the CPI inflation index, I think for now the situation is pretty much stable, I would say. The only thing that I would like to highlight is that international prices, meaning non-energy goods prices, are starting to weaken and that needs to be checked, needs to be monitored, because effectively they might actually push inflation down, but again, so far not a major shift and I think the ECB is still in a good place, still confident that inflation will stabilize.
Lorenzo, the governing council members that I've spoken to did flag up the euro as one of the things they're watching, but they're also concerned about the amount of excess goods that are arriving in Europe on the cheap, namely because of the tariffs, that the Chinese market share here has been growing. That point around the cheap goods coming through from the mainland market, do you think it undermines the price element we're talking about?
Yeah, again, I think there is evidence that indeed import prices are weakening. But if we look at the composition, indeed Chinese export prices are pretty stable. Actually they have increased. Meaning what? Meaning that effectively Chinese goods are not price competitive because of the price behavior of Chinese exporters. But they are competitive because of the extremely weak currency. So I think unless we address that issue globally, meaning allowing China to re-appreciate its currency, I would guess it would be difficult to argue in favor of dumping or deliberate overcapacity flooding in Europe. Again, it's a currency story mainly.
One of the other features we've still seen has been the strength in the services side. What's your view on how much of that strength persists from here?
Well, obviously if you have weakness in terms of goods prices, that is compensated by services to have inflation on target. So I think if services stay somewhat higher compared to the target, it's not so bad and so problematic. However, I think from here, given the projections that the ECB has in terms of wages and unit labor costs, services inflation, which is closely related to domestic demand, I think is going to weaken. So I think the latest number was 3.2. I think we are going to gradually decline from that level and approach the target. At the same time, I think the risk is that the latest numbers on wages were a bit higher compared to expectation. So the risk is that the expected slowdown in wages and unit labor costs does not materialize and therefore services inflation continues to stay too high to be seen as comforting. But my baseline case remains for a gradual moderation which again is consistent with the ECB inflation target and for that reason I think there's no need to change rates for probably throughout this year.
Oh well, Lorenzo, long hold, what you're seeing, I think others in the marketplace believe the same thing, but let's just see whether geopolitics and some of the other macro events globally hold this year. Lorenzo Codogno with us, founder and chief economist, Lorenzo Codogno Macro Advisory. We are just minutes out from the all-important announcement from the ECB. We will bring you the decision after the break.
We are now just moments away from the ECB's rate decision. A quick look at how we're perched on some of the big asset classes. It has been an eventful day in central banking. In fact, a lot of the news flow coming from the Bank of England. A split vote to leave rates where they were, but a dovish tilt and that has put more appetite back into some of the currencies. Euro is weaker against the dollar, but we have seen some strength versus sterling today. 1.1793 roughly the trade before we come up to the meeting. A look at some of the big European market trades elsewhere too as to how we are perched on the back foot and don't forget our markets. It's also been eventful. We've seen a lot of earnings out and also news flow around the tech software and the selling that we're seeing. So this morning as we move on to the rate decisions this afternoon, you can see what we've got today. The moves are on interest rates, unchanged is what we've got. We are still at the refinancing rate at 2.15%, the deposit facility at 2% as expected and the interest rate on the marginal lending facility unchanged at 2.4%. So all three rates unchanged as expected. The ECB saying the economy remains resilient in a challenging global environment. The low unemployment, solid private sector balance sheets, gradual roll out of public spending on defense and infrastructure are supportive. At the same time outlook is still uncertain owing particularly to ongoing global trade policy uncertainty and geopolitical tensions. So a couple of lines there. It is determined to ensure that inflation stabilizes at its 2% target and it will follow a data-dependent, meeting-by-meeting approach to determining appropriate monetary policy. Aneta, that would be mundane for central bankers to say that typically but not in the vain name when the Fed may be moving to some sort of conviction economics when it comes to decision-making. Take it away. What do you think of the decision today?
I think my first take is that it's a slight hawkish surprise because there's no mentioning of the exchange rate which might have a dampening effect on the inflation numbers going forward, but there is mention about the resilient economy and also the supportive effect from the gradual rollout of public spending on defense and infrastructure and also the supporting effects the past interest rate cuts did have. So all in all, the picture seems that the ECB rather looks at the rosier economy than the downside risks of inflation. Even though they of course do say that it's data dependent and they look at every data every time they make a decision. But as I said, the fact that they didn't mention the exchange rate as one of the factors pushing down inflation potentially might be a sign that they prefer to look to the other side of things. And that is also still reflected in the market expectations that the next move eventually towards the second half of this year could actually be a rate hike and not a rate cut. So but of course the jury is out. What happens to inflation going forward? Whether it's the economic forces who are rather pushing it up or whether it's the euro exchange rate and other factors that are pushing it down. If you look at the dispersion of inflation inside the euro area, it's not small countries, it's actually very dispersed. We have Italy as we were pointing out before and also France being really in a low inflationary environment. And here the governor for example of the Bank of France is publicly saying that they watch that exchange rate what it does to their inflation rate because clearly he must have a concern that inflation might actually get deflationary for his country given that the last reading was sitting at 0.4. Aggregate we all know it's 1.7, Italy only has 1% whereas Spain for example is much stronger, they have different dynamics in the economy and again the Baltics which did face a lot of inflation during the high inflationary period above 15%, they are still sitting above 4%. So it's a big picture and that also reflects the opinion picture inside the governing council. It's tough for them to come up with one unanimous voice when it comes to the next decision because clearly the economies do really look very differently. Karen,
Thank you so much for that. A great setup piece. I'm going to pick up on some of those points with Jamie Nann, senior fixed income portfolio manager at Candriam. Jamie, I was just pointing out to you off camera, very skinny statement today. We really didn't get very much from the ECB. But that whole point that Aneta was making that we didn't get any commentary around the strength in the euro despite all the outings from governing council members in recent weeks pointing to the strength and saying they are watchful of it. Does that surprise you?
Not at all actually. I expected a very boring meeting actually from the Bank of England and the ECB. Bank of England turned out to be a bit more interesting.
Indeed. But with the ECB, I mean yes we heard kind of murmurings from some members about the exchange rate but actually if we look at where the exchange rate is relative to December, there's not a huge amount of difference. Okay, we saw euro-dollar get to 1.20, it's come back to 1.18, but on a trade-weighted basis the euro's hardly moved actually in that time so I don't think it warranted anything within the statement. I'm sure that during the press conference there will be questions asked about it, but generally with the euro zone economy, I mean, we had Q4 GDP surprising to the upside. We had unemployment ticking down again. And okay, inflation's a bit lower than we expected, but I don't think it's material to warrant a big change in the rhetoric.
I want to get into that. The 1.7% that we saw on inflation in the euro zone is under the 2% target, but the line here, the language updated assessment reconfirms that inflation should stabilize at its 2% target in the medium term. So it looks like they're seeing through some of the bumps even to the downside here. Is that misguided? Because we know we've been through an environment where inflation has been much hotter than the central bankers would have liked. It's taken a lot to tame the inflation rate. Do you think they're just happy to see a low rate for now? And is that the right approach?
I don't know if they're happy to see a low rate because if we think historically they obviously had an undershoot problem with inflation. So there'll be a number of members who still have that in their memory as well. So I think it's balancing the two. We've had a long period of undershooting inflation, a shorter but still sustained period of overshooting inflation. We're now in and around that 2%. Okay, it's 1.7, but I don't think it's material enough to warrant a change. And I also think we've talked about the exchange rate and how okay we saw euro-dollar at 1.20 and if the dollar continues to weaken, maybe there is some deflationary impact of that. But on the flip side, we've seen commodity prices higher and actually since the December meeting, if we look at market-based expectations of inflation, they've ticked up as well. So, I don't think it's just looking at that 1.7% and saying we're below the 2% target. It's taking all of the information in and coming to the conclusion that actually, as we've heard many times from the ECB, they're in a good place.
Some of the positives here, the private sector balance sheets being solid, the gradual roll out of public sector spending on defense and infrastructure. We know these are big fiscal packages for Europe when it comes to Germany in particular by and large across the block. How supportive do you think that's going to be for growth when they're already talking about resilient growth?
The big question is the multiplier from this kind of defense spending, right? And what we don't know is the answer to that. I think there will be some impact and we're seeing that in the forecasts already and actually euro zone growth this year is forecast to be okay, you know, particularly compared to the recent past. So I think there's risks in both directions. If that multiplier turns out to be more than expected and we get more of that fiscal impulse coming through then growth is at or probably even slightly above potential, you know, so that doesn't warrant lower rates. But there is risk in both directions as I say.
You know, the ECB has not been afraid to weigh into the idea of central bank independence. In fact, they penned that letter in support of Jay recently thinking that the independence of the chair was in doubt. This line here saying it will follow a data dependent and meeting by meeting approach to determine appropriate monetary policy stance. I mean it looks like a very average statement from a central bank but I wonder whether it is these days because the nomination of Kevin Warsh over at the Fed and his view so far has to be more conviction based on decision-making, less data dependent. Do you think this is subtle messaging from the ECB? Am I reading too much into it?
You smiled. You think it could be, too.
No, no, no. I actually hadn't even thought about that. So, you're one step ahead of me there. Honestly, no. I don't think so. I don't think it's in reference to that. I mean, everyone within any position of power is very clear about the importance of central bank independence. And I think we've seen the market ramifications of potentially not independent central banks in the US over the last 6 to 12 months. So I think the ECB are very aware of that. But I don't think there's any question at the moment of their independence anyway. And therefore I don't know, maybe you're reading a little bit too.
Well, I'm just going to shuffle the question around a little bit because the ECB has been accused of being too data dependent, too meeting by meeting, and I've been one of the people accusing them of that every time I've sat down with the central bank governors because the lack of forward guidance has annoyed a lot of market participants. Should they be giving more guidance on where we're going from here? Waiting less for the data to have some sort of geopolitical gyrations.
My view on forward guidance is that often it's wrong. So what's the point in giving it? So actually I think the meeting by meeting for all central banks makes quite a lot of sense because so much new information comes in, so many data points, so much geopolitical and political headlines which do influence the outcome of the data eventually anyway. So if we give that forward guidance and it turns out to be incorrect then what is the worth of the forward guidance? So my view on forward guidance is it should be reduced somewhat without surprising markets too much. You know, you don't want unnecessary volatility, but we want to be able to react to what data actually comes in and not just set ourselves six months in advance say we're going to do this and then new information appears.
You know, the excitement today really has been around the Bank of England. So I might just pick up on that because I pointed out earlier that Andrew Bailey and the Bank of England managed to almost anchor the gilt market to an extent which it's been selling off today thanks to concerns around the political stability whether Keir Starmer is going to hold on to his job thanks to the furore over Mandelson. What do you think we need to think about in terms of riding out this gilt market trade from here?
It's been a difficult one. It's been a bumpy ride. I mean my view on the gilt market particularly and particularly the front end and the swap curve where there's less political influence I guess has been basically what we heard today the fact that rates should be lower and should in the future be lower still. And I think the outcome of the Bank of England today was quite clear in that front. I mean the market was pricing almost zero probability of a cut and we almost got one, right? I mean it just took barely. And honestly my inner feelings are that the reason that we didn't get a cut is because the market was pricing zero and they didn't want to have that unnecessary volatility. So it could have easily gone the other way. Bailey obviously in December was a little bit more dovish and if you read his paragraph it still reads dovish, right? It talks about rate cuts, not a cut. So I think without talking forward guidance and expectations, I wouldn't be surprised to see the Bank of England rate below 3.25%, which I think is even a little bit lower than what market's pricing even after today, by the end of this year.
And that's still restrictive territory though.
