Don’t expect rate cuts anytime soon, at least until the ECB sees a more consistent and compelling reduction in the near-term momentum of underlying inflation, Katharine Neiss writes in an article on finews.first.

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The European Central Bank (ECB) delivered a 25bp hike as expected at their July meeting, but the tone was much more open-ended and dovish than expected. The notable shift in tone relative to the ECB’s June meeting acknowledges the recent weak data flow.

As a reminder, GDP growth in Q1 was weak across the board, signaling weak domestic and external demand via euro-area exports. The purchasing managers indices for Q2 and more recently July, show a rapidly cooling economy, with manufacturing already in contraction and services coming off as well.

«An economy cannot defy gravity»

Yes, near-term momentum in underlying inflation remains elevated, but an economy cannot defy gravity, and eventually, weaker activity will translate into lower domestically generated inflation. Moreover, the latest ECB bank lending survey suggests there is more to come due to tightening credit conditions weighing on demand.

Markets will be relieved by the prospect that the risk of the ECB overtightening has receded. Based on what we are hearing from President Christine Lagarde, it looks like rates have peaked in the euro area.

That said, don’t expect rate cuts anytime soon, at least until the ECB sees a more consistent and compelling reduction in the near-term momentum of underlying inflation.

Katharine Neiss is the Deputy Head of Global Economics and Chief European Economist at PGIM Fixed Income.

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