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ECB likely to start rate cuts in June but inflation risks warrant caution – Wells Fargo

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The European Central Bank appears on course to start cutting its key interest rate in June from a record high but Wells Fargo said policy makers may take a cautious approach if cooling in inflation stalls.

ECB President Christine Lagarde has signaled rate cuts are likely at its June 6 meeting. That would beat the Federal Reserve to the punch in starting an easing cycle, with fed funds futures indicating the Fed will start reducing its benchmark rate in November.

The ECB is likely with a June reduction of 25 basis points to 3.75%, Nick Bennenbroek, international economist at Wells Fargo (WF) Economics, said in a note published this week. WF’s base case is of rate cuts of 100 bps this year to pull the ECB’s deposit rate down to 3% from 4%.

“If wage or price inflation fails to slow as much as we expect, the risk is tilted to a lesser 75 bps of cumulative easing to 3.25% over the rest of this year,” Bennenbroek said. Eurozone data released this week indicated labor cost pressures extended into Q1 and regional economic recovery was picking up momentum, he said.

“Persisting wage growth combined with strengthening recovery supports the case for the ECB to adopt a gradual approach to rate cuts during the early stages of its monetary easing cycle,” he said. “We expect the ECB to hold rates steady in July, before delivering another 25 bps rate cut in September.”

But even with the risk scenario, “the 75-100 bps of rate cuts we forecast is more than the easing currently priced in by market participants,” Bennenbroek said. A weaker trend for the euro (EUR:USD) may run until late 2024 considering market pricing and potentially diverging ECB and Fed policy paths, he said.

Data flagged by WF included the eurozone’s labor cost index initially showing Q1 labor costs firmed to 4.9% y/y and wages and salaries rose to 5%. While cost growth overall was still downwardly trending, those costs are easing “only gradually,” Bennenbroek said.

Meanwhile, the eurozone’s May manufacturing PMI rose to 47.4, the best reading since February 2023. Services PMIs were “a bit mixed” with Germany’s reading increasing in May while France’s declined. The May PMI surveys suggest upside risk to WF’s eurozone 2024 GDP growth forecast of 0.8%, Bennenbroek said.

In the markets, the Stoxx Europe 600 (STOXX)(EZU)(BBEU) has risen nearly 9% in 2024. The euro (EUR:USD) has lost nearly 2% versus the U.S. dollar (DXY).

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