It seems that the Euro Area economy is flashing all the wrong signs. Stock markets are pushing to new record highs despite the economy being essentially stagnating. The ECB (European Central Bank) cut rates and is widely expected to do so again despite inflation rising in the last report. Governments are trying to constrain spending even as the economy struggles. What’s going on?
To complicate matters for currency traders, the ECB (European Central Bank) seems to be having doubts about its policy. There has always been a North-South divide in monetary policy, but faced with a slowing economy and inflation moving towards target, last year it seemed they were both on the same page about easing. Many officials are still talking about reaching 2.0% interest rates this year. That implies another 75 bps of easing (or three cuts) by December. But others say the time has come to debate whether it’s prudent to pause the easing. Those include representatives from Germany who say that interest rates can be higher than previously thought and not be a drag on the economy.
The Grand Debate
German representative to the ECB Isabel Schnabel argued that weakness in the Euro Area isn’t due to high borrowing costs, but structural factors. Lending in the shared economy has increased since the central bank started cutting, but neither growth nor investor confidence have picked up in the same period.
Her comments echo pre-pandemic typical talking points of the Draghi-era ECB which constantly bemoaned the lack of structural reforms to revitalize the economy. European GDP growth was anemic back then, despite even negative rates. Aspects pushing up inflation in the shared economy seem unrelated to monetary policy, such as higher energy costs from the war in Ukraine, increasing housing prices from lack of supply, and the threat of tariffs.
It’s Not a Consensus
Schnabel remains a minority in the discussion, with the market effectively pricing in a rate cut at the next meeting. This is in line with ECB President Christine Lagarde sticking to pretty much the same rhetoric since the start of the year: Inflation is coming down, it will reach the target, we’re concerned about the economy.
Bracketing the weekend is flash inflation data from major Euro Area economies, which would provide some insight into whether that prediction is coming true. Inflation was expected to rise through the winter as the continent needs more energy to get through the cold months. But with relatively modest weather in February, now could be the test to see if inflation turns downward. A rise might not be enough to derail expectations of a rate cut, but it could intensify the debate and give the Euro a boost.
What the Data Could Say
Friday sees the release of flash French February CPI, which is expected to fall to 1.4% from 1.7% prior. That is below the 2.0% target for the ECB, but likely to be due to more volatile factors. A few hours later it’s the largest economy in the Euro Area’s turn, with German annual inflation expected to ease modestly to 2.2% from 2.3% prior.
Then we jump to Monday when we get the data set for the whole of the Eurozone, which is essentially expected to remain unchanged. Headline inflation is forecast at 2.5%, the same as in January. And the core rate is seen at 2.7%, repeating the prior month’s reading. This provides an opportunity for a beat or miss of just one decimal to shake up the markets. A beat would imply we’ll have to wait another month for inflation to start to normalize. A miss would imply inflation is heading in the right track to keep easing.