Is the ECB in panic mode to avoid a hard landing of the EU?

·         EU may face a double whammy of Chinese and Trump trade war tantrum 2.0 (if Trump is reelected again); Germany, France, and Italy may suffer the most

·         Despite average core HICP disinflation stalled in Q2 and 6MRA remaining around 2.8% against pre-COVID levels of 1.3%, the ECB goes for back-to-back rate cuts

·         ECB’s actual target of +2.0% core inflation is equivalent to 1.5% core HICP (w/o food, energy, tobacco, and alcohol)

·         EZ real GDP growth for CY23 was +0.4% and the current ECB estimate for CY24 is only +0.8% against pre-COVID trend rate/potential +2.0%

·         EZ Harmonized unemployment average rate is now 6.5%, unusually high for an AE; ECB should be given a Fed-like dual mandate of maximum employment and price stability.

On 17th October (Thursday), apart from relentless Fed talks (forward guidance), some focus of the market was also on the ECB’s monetary policy decision. As highly expected, the ECB cut all three key rates by -25 bps. Accordingly, the ECB rates on the deposit rate facility (DRF-reverse repo), reference rates on the main refinancing operations (MRO-interbank rate), and rates on the marginal lending facility (MLF-repo rate) will be decreased to 3.25%, 3.40%, and 3.65% respectively, with effect from 23rd October 2024.

ECB kept rates on hold until June’24 meeting at a 22-year high after 10th consecutive rate hikes till Sep’23 (cumulating +450 bps since July 22). From June’24, till Sep’24, the ECB cuts its main DRF rates by -75 bps, while for spread adjustment, cuts MLF and MRO by additional -35 bps. As unanimously expected, in Sep’24, the ECB cut its interest rate by -25 bps on the deposit facility (DRF-reverse repo) to +3.50%, while cutting interest rates on the marginal lending facility (MLF-repo rate) and reference interest rates on the main refinancing operations (MRO-interbank rate) by -60 bps each to +3.90% and +3.65% respectively.

When banks earn a higher spread between repo and reverse repo rates or between interbank and repo/reverse repo rates, they tend to deploy more funds in lending operations (direct to borrowers or other banks) rather than depositing the same with the central bank to earn a lower risk-free return. As the ECB reduced these spreads despite cutting rates drastically (as it seems) by -60 bps for repo and interbank rates along with an orderly -25 bps for reverse repo rate, it may discourage banks from lending more rather than deploying the excess fund with ECB to earn a risk-free return.

Thus despite cutting repo and interbank lending rates big by -60 bps, the overall stance of the ECB is less dovish; i.e. it’s a dovish cut by the ECB. As usual, after the ECB meeting, ECB sources almost confirmed that the ECB may cut next in Dec’24 (QTR end) unless there are some exigencies (worst economic data) ahead of the October meeting. Thus EIRUSD got some boost after the Sep’24 meeting.

But still now spread between the repo (MLF) and reverse repo rate (DRF) is now +40 bps, which is substantially higher than the normal +25 bps and the Fed’s +10 bps and should encourage banks to lend. Also, the spread between the repo and interbank rate is unchanged at +25 bps (MLF-MRO). For any developed Central Bank, the overnight/short-term secured interbank rate is the main rate at which banks lend to each other for their liquidity management.

As per ECB, the Oct’24 back-to-back rate cut decision stems from an updated assessment of inflation, which shows disinflation progressing well. In September, headline inflation (CPI) in the Eurozone fell to 1.7%, below the ECB’s official target of 2.0% for the first time in more than three years. While inflation is expected to rise in the short term, it should decline toward the 2% target in 2025. Wage growth and domestic service inflation remain high, but pressures are easing. The ECB remains committed to sufficiently restrictive rates to ensure inflation reaches its medium-term goal, using a data-driven, flexible approach without committing to a specific rate path.

But in reality, the ECB may have decided to front-load some 2025 rate cuts in 2024 and thus also goes for a consecutive -25 bps rate cut in Oct’24 as the German economy is now going through a rough patch; in almost recession or rather than visible stagflation like scenario (lower GDP growth rates, higher unemployment, and even sticky core inflation). The export-savvy German economy is largely dependent on the automobile industry, while China is the biggest trading partner/client (for German exports).

In Dec’24, the ECB may further cut all rates (MLF, DRF, and MRO) by -25 bps unless economic data comes much hotter than expected... Central banks generally target overnight interbank rates (like SOFR for Fed) to align with the official fixed reverse repo rate, so that the interbank funding market runs smoothly and all banks lend to each other for their funding requirement rather than lending from the central bank repo window, which is the last resort for financial stability, especially during QT.

Fed’s SOFR (Secured Overnight Lending Rate) is now around +5.33% against a reverse repo rate of +5.40% and repo rate of +5.50%. During late 2019, even before COVID, there was a brief repo (funding) market crisis due to excessive QT by the Fed (compared to the demand for liquidity) and SOFR jumped to an even +5.40% against the then reverse repo rate of +2.15% and repo rate +2.25% when Fed was trying to normalize through QT and rate hikes. This led to a Fed mini QE even before COVID; after COVID, the Fed introduced ON-RRP to manage banking liquidity in both directions (injections or absorptions) to prevent such a repo market crisis. In the longer run, when such an interbank rate comes closer to the reverse repo rate, the cost of funds for banks also comes lower, which may also push down bond yields and overall cost of borrowing for not only banks but also its borrowing clients.

Full Text of ECB statement: Monetary policy decisions: 17th Oct’24

Monetary policy decisions

“The Governing Council today decided to lower the three key ECB interest rates by 25 basis points. In particular, the decision to lower the deposit facility rate – the rate through which the Governing Council steers the monetary policy stance – is based on its updated assessment of the inflation outlook, the dynamics of underlying inflation, and the strength of monetary policy transmission. The incoming information on inflation shows that the disinflationary process is well on track. The inflation outlook is also affected by recent downside surprises in indicators of economic activity. Meanwhile, financing conditions remain restrictive.

Inflation is expected to rise in the coming months, before declining to target in next year. Domestic inflation remains high, as wages are still rising at an elevated pace. At the same time, labor cost pressures are set to continue easing gradually, with profits partially buffering their impact on inflation.

The Governing Council is determined to ensure that inflation returns to its 2% medium-term target in a timely manner. It will keep policy rates sufficiently restrictive for as long as necessary to achieve this aim. The Governing Council will continue to follow a data-dependent and meeting-by-meeting approach to determining the appropriate level and duration of restriction. In particular, its interest rate decisions will be based on its assessment of the inflation outlook in light of the incoming economic and financial data, the dynamics of underlying inflation, and the strength of monetary policy transmission. The Governing Council is not pre-committing to a particular rate path.

Key ECB interest rates

The Governing Council today decided to lower the three key ECB interest rates by 25 basis points. Accordingly, the interest rates on the deposit facility, the main refinancing operations, and the marginal lending facility will be decreased to 3.25%, 3.40%, and 3.65% respectively, with effect from 23 October 2024.

Asset Purchase Program (APP) and Pandemic Emergency Purchase Program (PEPP)

The APP portfolio is declining at a measured and predictable pace, as the Eurosystem no longer reinvests the principal payments from maturing securities.

The Eurosystem no longer reinvests all of the principal payments from maturing securities purchased under the PEPP, reducing the PEPP portfolio by €7.5 billion per month on average. The Governing Council intends to discontinue reinvestments under the PEPP at the end of 2024.

The Governing Council will continue applying flexibility in reinvesting redemptions coming due in the PEPP portfolio, to counter risks to the monetary policy transmission mechanism related to the pandemic.

Refinancing operations

As banks are repaying the amounts borrowed under the targeted longer-term refinancing operations, the Governing Council will regularly assess how targeted lending operations and their ongoing repayment are contributing to its monetary policy stance.

The Governing Council stands ready to adjust all of its instruments within its mandate to ensure that inflation returns to its 2% target over the medium term and to preserve the smooth functioning of monetary policy transmission. Moreover, the Transmission Protection Instrument is available to counter unwarranted, disorderly market dynamics that pose a serious threat to the transmission of monetary policy across all euro area countries, thus allowing the Governing Council to more effectively deliver on its price stability mandate.”

Text of the opening statement by ECB President Lagarde: 17th Oct’24

“The Governing Council today decided to lower the three key ECB interest rates by 25 basis points. In particular, the decision to lower the deposit facility rate – the rate through which we steer the monetary policy stance – is based on our updated assessment of the inflation outlook, the dynamics of underlying inflation, and the strength of monetary policy transmission. The incoming information on inflation shows that the disinflationary process is well on track. The inflation outlook is also affected by recent downside surprises in indicators of economic activity. Meanwhile, financing conditions remain restrictive.

Inflation is expected to rise in the coming months, before declining to target in next year. Domestic inflation remains high, as wages are still rising at an elevated pace. At the same time, labor cost pressures are set to continue easing gradually, with profits partially buffering their impact on inflation.

We are determined to ensure that inflation returns to our two percent medium-term target in a timely manner. We will keep policy rates sufficiently restrictive for as long as necessary to achieve this aim. We will continue to follow a data-dependent and meeting-by-meeting approach to determining the appropriate level and duration of restriction. In particular, our interest rate decisions will be based on our assessment of the inflation outlook in light of the incoming economic and financial data, the dynamics of underlying inflation, and the strength of monetary policy transmission. We are not pre-committing to a particular rate path.

I will now outline in more detail how we see the economy and inflation developing and will then explain our assessment of financial and monetary conditions.

Economic activity

The incoming information suggests that economic activity has been somewhat weaker than expected. While industrial production has been particularly volatile over the summer months, surveys indicate that manufacturing has continued to contract. For services, surveys show an uptick in August, likely supported by a strong summer tourism season, but the latest data point to more sluggish growth. Businesses are expanding their investment only slowly, while housing investment continues to fall. Exports have weakened, especially for goods.

Although incomes rose in the second quarter, households consumed less, contrary to expectations. The saving rate stood at 15.7 percent in the second quarter, well above the pre-pandemic average of 12.9 percent. At the same time, recent survey evidence points to a gradual recovery in household spending.

The labor market remains resilient. The unemployment rate stayed at its historical low of 6.4 percent in August. However, surveys point to slowing employment growth and a further moderation in the demand for labor.

We expect the economy to strengthen over time, as rising real incomes allow households to consume more. The gradually fading effects of restrictive monetary policy should support consumption and investment. Exports should contribute to the recovery as global demand rises.

Fiscal and structural policies should be aimed at making the economy more productive, competitive, and resilient. That would help to raise potential growth and reduce price pressures in the medium term. To this end, it is crucial to swiftly follow up, with concrete and ambitious structural policies, on Mario Draghi's proposals for enhancing European competitiveness and Enrico Letta’s proposals for empowering the Single Market. Implementing the EU’s revised economic governance framework fully, transparently, and without delay will help governments bring down budget deficits and debt ratios on a sustained basis. Governments should now make a strong start in this direction in their medium-term plans for fiscal and structural policies.

Inflation

Annual inflation fell further to 1.7 percent in September, its lowest level since April 2021. Energy prices dropped sharply, at an annual rate of -6.1 percent. Food price inflation went up slightly, to 2.4 percent. Goods inflation remained subdued, at 0.4 percent, while services inflation edged down to 3.9 percent.

Most measures of underlying inflation either declined or were unchanged. Domestic inflation is still elevated, as wage pressures in the euro area remain strong. Negotiated wage growth will remain high and volatile for the rest of the year, given the significant role of one-off payments and the staggered nature of wage adjustments.

Inflation is expected to rise in the coming months, partly because previous sharp falls in energy prices will drop out of the annual rates. Inflation should then decline to target in next year. The disinflation process should be supported by easing labor cost pressures and the past monetary policy tightening gradually feeding through to consumer prices. Most measures of longer-term inflation expectations stand at around 2 percent.

Risk assessment

The risks to economic growth remain tilted to the downside. Lower confidence could prevent consumption and investment from recovering as fast as expected. This could be amplified by sources of geopolitical risk, such as Russia’s unjustified war against Ukraine and the tragic conflict in the Middle East, which could also disrupt energy supplies and global trade. Lower demand for euro-area exports due, for instance, to a weaker world economy or an escalation in trade tensions between major economies would further weigh on euro-area growth.

Growth could also be lower if the lagged effects of monetary policy tightening turn out stronger than expected. Growth could be higher if the world economy grows more strongly than expected or if easier financing conditions and declining inflation lead to a faster rebound in consumption and investment.

Inflation could turn out higher than anticipated if wages or profits increase by more than expected. Upside risks to inflation also stem from the heightened geopolitical tensions, which could push energy prices and freight costs higher in the near term and disrupt global trade. Moreover, extreme weather events, and the unfolding climate crisis more broadly, could drive up food prices. By contrast, inflation may surprise on the downside if low confidence and concerns about geopolitical events prevent consumption and investment from recovering as fast as expected, monetary policy dampens demand more than expected, or if the economic environment in the rest of the world worsens unexpectedly.

Financial and monetary conditions

Shorter-term market interest rates have declined since our September meeting, owing mainly to weaker news on the euro area economy and the further fall in inflation. While financing conditions remain restrictive, the average interest rates on new loans to firms and on new mortgages were down slightly in August, to 5.0 percent and 3.7 percent respectively.

Credit standards for business loans were unchanged in the third quarter, as reported in our latest bank lending survey, after more than two years of progressive tightening. Moreover, demand for loans by firms rose for the first time in two years. Overall lending to firms continues to be subdued, growing at an annual rate of 0.8 percent in August.

Credit standards for mortgages eased for the third quarter in a row, owing especially to greater competition among banks. Lower interest rates and better housing market prospects led to a strong increase in the demand for mortgages. In line with this, mortgage lending picked up slightly, growing at an annual rate of 0.6 percent.

Conclusion

The Governing Council today decided to lower the three key ECB interest rates by 25 basis points. In particular, the decision to lower the deposit facility rate – the rate through which we steer the monetary policy stance – is based on our updated assessment of the inflation outlook, the dynamics of underlying inflation, and the strength of monetary policy transmission. We are determined to ensure that inflation returns to our two percent medium-term target in a timely manner.

We will keep policy rates sufficiently restrictive for as long as necessary to achieve this aim. We will continue to follow a data-dependent and meeting-by-meeting approach to determining the appropriate level and duration of restriction. In particular, our interest rate decisions will be based on our assessment of the inflation outlook in light of the incoming economic and financial data, the dynamics of underlying inflation, and the strength of monetary policy transmission. We are not pre-committing to a particular rate path. In any case, we stand ready to adjust all of our instruments within our mandate to ensure that inflation returns to our medium-term target and to preserve the smooth functioning of monetary policy transmission.”

Highlights of ECB President Lagarde’s comments during Q&A (Presser): 17th Oct’24

·         ECB is quite confident about the overall disinflation pace that it’s going towards targets on a sustainable basis

·         Overall data in the last 5-weeks after the Sep’24 meeting indicates lower inflation and also lower economic activities.

·         ECB is quite concerned about any repeat of the Trump trade war tantrum (if Trump indeed wins the Nov’24 US election) as trade is also an important economic activity apart from consumption and investment

·         ECB is concerned about subdued EU economic activities and also has an internal debate/discussions of a jumbo rate cut of -50 bps; but -25 bps was on the plate and at the end of the day, the decision was unanimous

·         ECB may consider any jumbo rate cut probability after a detailed staff economic report & outlook thereof in the Dec’24 meeting

·         ECB’s single mandate is only to ensure price stability (not a Fed-like dual mandate of maximum employment and price stability

·         ECB considers data/reports of overall economic activities, labor market/employment situation, and also price stability, but at the end of the day, the policy is driven by underlying actual inflation, inflation outlook, and monetary policy transmission

·         ECB does not recalibrate policies but only calibrates

·         ECB is data dependent, not data point dependent; i.e. ECB looks into overall data trends rather than a particular month to avoid any policy error

·         ECB is cognizant of the fact that global oil prices may further surge amid the escalating Gaza and Ukraine war along with Chinese stimulus; there is some upside risk in inflation and downside risk in GDP growth

·         ECB is still hopeful for a soft landing and still now, based on available data, does not see any all-out recession

·         But the ECB is of the view that slowing GDP growths/economic activities may hamper inflation and inflation outlook (as subdued economic activities are causing muted demand, putting the supply capacity of the economy in surplus)

·         ECB thinks there is no ambiguity in the policy language that the ECB will keep policy rates sufficiently restrictive for as long as necessary to achieve price stability aim; i.e. ECB is determined to ensure that inflation returns to the 2% medium-term target in a timely manner on a durable basis (symmetrical way)

·         ECB’s restrictive rate actions are working as inflation is gradually falling, but it’s not a victory yet

·         ECB is confident more about the overall disinflation process due to the recent fall in core inflation and service inflation

·         ECB will take into consideration various data between September and November for the December policy meeting along with ECB staff projections

·         Although the ECB was a little surprised by the rapid fall in total CPI and core CPI in Sep’24 to +1.7% and +2.7%, it decided on another 25 bps rate cut by considering the overall disinflation trend for the last few months and it will continue to employ this strategy of overall data (trend) dependent, not data point dependent; i.e. ECB will not act only one or two months of data.

·         ECB believes that it has not yet broken the neck of inflation but is in the process of doing so

·         ECB is very cautious and attentive to the upside risk of inflation due to still elevated food and energy prices coupled with service inflation

·         ECB is very nimble and attentive to data; will continue the data-dependent approach

·         ECB is now not in a position to outline Dec’24 economic projections & outlook, but the ECB will continue to ensure restrictive rate (real positive) until inflation falls to +2.0% symmetrical (+/- 0.50%) targets on a durable basis

·         ECB does not anticipate an all-out recession in the EU despite subdued economic growth in Germany, the largest economy in the EU/Europe; manufacturing in the heavy German economy is different from most other service-oriented EU economy

·          ECB seeks an early fiscal consolidation strategy in line with the EU fiscal governance framework to boost fiscal stimulus and implement various reforms in the next 4-7 years

·         It’s the responsibility of the fiscal authority of various EU member states (countries) to act prudently for better productivity, while the ECB ensures price stability; both have to coordinate and play their part.

Highlights of ECB meeting and Lagarde statements, and Q&A (Presser): 17th Oct’24

·         ECB MRO Interest Rate Actual 3.40% (Forecast 3.4%, Previous 3.65%)

·         Eurozone ECB Rate On Deposit Facility in line with forecasts (3.25%)

·         ECB cuts key rates by 25 bps in October monetary policy decision, as expected

·         Domestic inflation is high and wages are rising at an elevated pace

·         ECB Cuts Rates As Expected With Disinflation ‘Well On Track’. Keeps Guidance Unchanged

·         Labor cost pressures are set to continue easing gradually, with profits partially buffering their impact on inflation

·         The inflation outlook is also affected by recent downside surprises in indicators of economic activity

·         APP and pandemic emergency purchase program (PEPP) APP portfolio is declining at a measured and predictable pace, as Eurosystem no longer reinvests principal payments from maturing securities

·         The Eurosystem will no longer reinvest all of the principal payments from maturing securities purchased under PEPP, reducing the PEPP portfolio by €7.5 billion per month on average (QT)

·         Accordingly, interest rates on the deposit facility, main refinancing operations, and marginal lending facility will be decreased to 3.25%, 3.40%, and 3.65% respectively, with effect from 23rd October 2024

·         The ECB intends to discontinue reinvestments under PEPP at the end of 2024

·         We will continue applying flexibility in reinvesting redemptions coming due in PEPP portfolios to counter risks to monetary policy transmission mechanisms related to the pandemic

·         We will keep policy rates sufficiently restrictive for as long as necessary

·         The ECB will continue to follow a data-dependent and meeting-by-meeting approach to determining the appropriate level and duration of restriction

·         In particular, our interest rate decisions will be based on an assessment of the inflation outlook in light of incoming economic and financial data, dynamics of underlying inflation, and strength of monetary policy transmission

·         The ECB is not pre-committing to a particular rate path

·         The inflation outlook is also affected by recent downside surprises in indicators of economic activity

·         Meanwhile, financing conditions remain restrictive

·         Domestic inflation remains high, as wages are still rising at an elevated pace

·         In particular, our interest rate decisions will be based on an assessment of the inflation outlook in light of incoming economic and financial data, dynamics of underlying inflation, and strength of monetary policy transmission

·         ECB's President Lagarde: We expect the economy to strengthen over time

·         Surveys suggest slowing employment growth

·         Recent surveys point to a gradual recovery in household spending

·         Latest data points to more sluggish growth

·         Households consumed less than expected

·         Investment is expanding only slowly

·         Incoming data suggests that activity is weaker than expected

·         Risks to growth are on the downside

·         Inflation to drop to target in 2025

·         Most underlying inflation measures dropped or held

·         Domestic inflation is still strong

·         The decision was unanimous

·         Any additional trade barriers are a downside for Europe

·         The disinflationary process is well on track

·         Financing conditions remain restrictive

·         Downside risks to inflation include low confidence, geopolitical stress, and low investment

·         Geopolitical tensions are an upside inflation risk

·         We still have risks on both sides of the inflation forecast

·         There is no question that we are currently restrictive

·         I don't see a recession in the Eurozone shortly as per available data

·         I am still expecting a soft landing

·         I didn't open the door to anything

·         Risks to inflation may be a bit more on the down, not upside

·         We haven't yet broken the neck of inflation but we are in the process

Customary ECB Sources (after ECB meeting): Forward Guidance

·         Some ECB governors at this week's meeting wanted to drop their pledge to keep policy tight

·         Some ECB governors wanted to drop the pledge of tight policy

·         Unless there is an unusual improvement in the underlying economic data, the ECB is set for another rate cut in Dec’24

Further on Friday (18th Sep’24), ECB’s Villeroy said:

·         The risk of durably undershooting is now as big as overshooting it

·         We should reach our 2% inflation target sooner than expected in 2025

·         Slowing private investment and consumption along with rising savings rates justify the latest rate cut

·         The pace of future rate cuts must be guided by agile pragmatism

·         We must be faithful to our mandate and symmetry of inflation target

·         We have total optionality for the upcoming meetings

·         ECB should keep cutting interest rates as appropriate

·         The rate-cut rhythm should be one of agile pragmatism

On Friday, ECB’s Makhlouf said:

·         I don't believe ECB rates should have been cut faster

Conclusions:

In Sep’24, the annual Euro Zone HICP Core CPI (w/o energy, food, alcohol, and tobacco) eased to +2.7%, from +2.8% sequentially, at 5-months low after a substantial decline from recent top +5.7% in Mar’23 amid lower oil/energy prices (indirect transmission to core inflation), but still substantially higher than the Dec’19 (pre-COVID) levels of +1.3%. The EZ Core HICP inflation may be equivalent to US core PCE inflation based on core consumer expenditure. The EZ service inflation was +3.9% in Sep’24, eased from +4.1% sequentially, but still substantially higher than +1.9% pre-COVID levels (Dec’19). The EZ Rent Inflation edged up to +3.0% in Sep’20 from +2.90% sequentially, but still substantially higher than +1.5% pre-COVID levels (Dec 19).

The EZ service inflation has also stuck around +4.0% for the last 8 months on average, still quite elevated against pre-COVID levels of +2.0%. Also, EZ rent inflation surged to +3.0% recently after hovering around +2.7% since early 2024 and quite elevated compared to +1.3% on average in pre-COVID times. The rise in service/housing/rent inflation may be due to robust travel & tourism amid a warm winter and pleasant summer in Europe this year coupled with a post-COVID boost and also increasing immigration/workers/labor force coupled with higher population, equivalent to almost the entire US population around 350M. This is creating higher demand for renting and housing, while supply remains constrained and boosting domestic inflation.

The 6M and YTM rolling average of EZ HICP Core CPI is now around +2.8% after Sep’24, unchanged from Aug’24. The 3M rolling average (Q3) was +2.8%, unchanged from Q1CY24; i.e. core HICP disinflation stalled in Q2 after a meaningful disinflation from +3.1% in Q1CY24. The 2024-YTM average core HICP was +2.8% in Sep’24 against the 2023 average of +5.0%, and the pre-COVID CY2019 average of +1.1%.

The EZ core HICP YTM sequential (m/m) rate is now around +0.3%; i.e. annualized rate is almost around +3.8%. The rapid fall in annual core CPI is a favorable base effect, which may reverse in Q4CY24 and early 2025. At present and trend sequential rate, the EZ core HICP may fall to around +2.0% symmetrical levels by Dec’25, while the actual target (pre-COVID) of 1.3-1.5-1.8% symmetrical levels by Dec’26. In this way, like in the US, the EZ inflation/price is still around +20% higher than pre-COVID CY19 levels.

The EZ core HICP inflation (w/o food, fuel/energy, alcohol, and tobacco) is different from normal core CPI inflation (w/o food & fuel/energy) even after harmonization and maybe around 1.00-0.70% lower than core CPI. The EZ HICP inflation in the Euro Area remained below +2.0% for much of the period between 2010 and 2020, often hovering around +1.0%. However, after the 2020 COVID disruption and recession effect, the EZ HICP in 2021-2022, inflation surged due to COVID-related supply chain disruptions, fiscal stimulus, and rising energy prices, though the core HICP inflation began rising more notably in mid-2022 after the Russia-Ukraine war and subsequent economic sanctions on Russia. In 2022-2023, EZ core HICP inflation accelerated, peaking around 5.7% amid persistent price pressures in services and non-energy industrial goods due to wage growth and supply bottlenecks.

The EZ real GDP growth is around +0.4% in 2023 (y/y) against an average of 1.7% in 2018-19 (pre-COVID). The trend rate of EZ real GDP growth should be around +2.0%. In Q2CY24, the EZ real GDP growth was around +0.6% (y/y), while the average unemployment rate was around 6.5% against Q3CY29 real GDP growth was +1.9% and unemployment rate +7.5%, while core HICP inflation was around +1.1%. As per Taylor’s rule, for the ECB/EU:

Recommended policy repo rate for ECB/EU Considering inflation, unemployment, and GDP growth equations, the ECB should maintain an average repo rate of at least around +3.40% in 2024 and +1.70% in 2025. Growing real policy divergence between the Fed and ECB along with a stagflation-like scenario in the EU is keeping EURUSD under stress, causing more imported inflation as the EU depends on both fuel and food imports. Thus despite the ECB narrative of translantic divergence, in the longer term, the ECB may have to follow the Fed in real policy action, whatever may be the narrative.

Looking ahead considering recent economic data and Fed talks, the Fed may pause in Nov’24 and may cut -25 bps in Dec’24 followed by a similar -25 bps cut four times in 2025-26 (every other meeting/every QTR end) for a terminal repo rate +3.00% by Dec’26 against targeted core CPI inflation around +2.00%.

Looking ahead, considering subdued economic activities and employment data, the ECB may cut -25 bps again in Dec’24, followed by a regular -25 bps cut each QTR end in 2025-26 in line with Fed for a repo rate (MLF) around +1.40% by Dec’26 against core HICP inflation average +1.90%. By 2027, the EU core HICP average should be around +1.30%, which would be equivalent to a core CPI rate of around +2.00%.

Bottom line:

ECB should be given a Fed/US-like dual mandate of maximum employment and price stability, while EU/EZ member states should employ sufficient fiscal/infra stimulus with proper policy reform to encourage the manufacturing sector to be able to compete with China, Korea, Japan and US for mass employment.

Weekly-Technical trading levels: EURUSD

Looking ahead, Whatever may be the fundamental narrative, technically EURUSD (1.08600) has to sustain above 1.08000 for any recovery to 1.08800/1.09200-1.09500/1.10000 and rally further to 1.10600/1.11100 and 1.11900/1.12300-1.12500/1.13000 and even 1.14500-1.17400 in the coming days; otherwise sustaining below 1.08000, may further fall to 1.07600/1.07400-1.07000/1.06600 and  1.06000/1.05300-1.05000/1.04400 in the coming days.