The market reduces interest rate cut bets, the European Central Bank disagrees! Officials insist on four rate cuts by June

Zhitong Finance has learned that the European Central Bank (ECB) is rebutting some investors' views—investors believe that stronger inflation, a slowdown in the Federal Reserve's interest rate cuts, and the economic turmoil brought by Trump will limit the space for rate cuts. Although the market has lowered its expectations for the number of rate cuts by the ECB and the Federal Reserve this year, ECB officials remain unfazed. ECB Governing Council member and Governor of the Bank of France Villeroy, along with the Governor of the Bank of Greece Stournaras, reiterated the long-held view that by mid-2025, the deposit rate will drop from the current 3% to around 2%. This could mean that the bank will announce rate cuts at every monetary policy meeting in the first half of the year.

Currently, they are considering the increasing uncertainty in the policy outlook, which mainly stems from U.S. trade policies, as well as the more hawkish stance of the Federal Reserve and political turmoil in Germany and France. Although the ECB may still change its course, it is unlikely to do so at least until digesting the quarterly forecast in March, which will reflect the impact of Trump's initial actions after taking office.

Gilles Moec, Chief Economist at AXA Investment Managers, stated: “Markets often react too quickly, and central banks on both sides of the Atlantic will strive not to overreact to a single data point. Since Trump's inauguration, we should have a better understanding of his 'conversion rate' from campaign proposals to policy implementation.”

ECB President Christine Lagarde promised last December to continue following a "data-dependent, meeting-by-meeting approach" when setting interest rates. Since then, data in Europe has hardly deviated from expectations. While some traders may have focused on the recent uptick in inflation, the ECB had previously indicated a rebound in inflation by the end of the year. ECB analysts believe that the overall decline in price increases will progress as expected and anticipate that wage pressures will ease by 2025. Meanwhile, even before Trump began imposing tariffs, the Eurozone economy was still struggling.

In fact, developments in the U.S. may explain why the market is currently only pricing in three 25 basis point rate cuts by June—one less than at the beginning of 2025. First, the U.S. labor market continues to ignore predictions that it will soften. Additionally, Trump's tax cuts and immigration policy outlook may keep inflation elevated. In December, Federal Reserve policymakers had already reduced their expected number of rate cuts in 2025 from four to two. Traders now believe there will only be one rate hike this year, and economists from BNP Paribas and Nikko Asset Management even question whether the next step will be a rate hike This has reignited a debate since 2024 about how divergent the policies of the European Central Bank and the Federal Reserve can be. As before, European Central Bank officials, including Croatian National Bank Governor Vujcic, quickly dismissed claims that they are overly influenced by their American counterparts.

Barclays Chief Economist Christian Keller stated, "A cautious Federal Reserve will not prevent the European Central Bank from further rate cuts. The European Central Bank will want to closely monitor exchange rates to avoid significant and sudden depreciation, but in principle, it will not avoid cutting rates."

Since September 30, the euro's trade-weighted exchange rate has fallen by about 3%, and the euro has depreciated by more than 8% against the dollar, dangerously close to parity. The last time this level was breached was in 2022, when the Russia-Ukraine war broke out, causing energy prices to soar.

Allianz Chief Economist Ludovic Subran said that while a weaker euro could bring new inflation risks, they may be limited; given the looming trade war, the European Central Bank may focus more on economic growth issues.

Finnish Central Bank Governor Rehn stated on Monday, "In the context of anti-inflation measures being on track and a weakening growth outlook, continuing to cut rates makes sense," adding that the scale and speed of rate cuts will be determined by upcoming data.

Despite warnings that if borrowing costs remain too high for too long, price increases could significantly fall below targets, investors may still need more persuasion to believe that the European Central Bank will follow through on the four rate cut hints already issued by many of its policymakers.

Pooja Kumra, Senior Rates Strategist at Toronto-Dominion Bank for the UK and Europe, said, "The market expects to hear similar comments from Rehn and other dovish figures. But we need to see more hawkish officials like Lagarde and Schnabel take similar stances for the market pricing to change."

On Tuesday, European Central Bank hawkish official Holzmann was reluctant to do so. While he is known for his extreme positions, he stated that the next policy decision to be made on January 30 is still unclear