Powell and Lagarde share notes on possible rate cuts

We have had a busy week on the central bank front with the Federal Reserve chair Jerome Powell’s semi-annual testimony to congress on Wednesday before Christine Lagarde took centre stage at the European Central Bank press conference yesterday. 
 
Much of the discussion from the two central bankers was similar, and you’d be forgiven for thinking that they had shared notes before speaking. Powell, as he said at the last FOMC, has confidence that inflation is moving towards the Fed’s 2% target but wants “greater” confidence before pulling the trigger on rate cuts. Similarly, Lagarde spoke about not being “sufficiently” confident that inflation was moving sustainably and durably towards the ECB’s 2% target.
 
You don't have to listen particularly closely to understand how they will get this confidence of course. With goods providing a disinflationary tailwind last year, the progress on headline and core masks services inflation that remains above the level the central banks think is consistent with their targets. Given the fact that wages make up a large proportion of the cost base for most service businesses, it's no surprise that the Fed and the ECB remain laser focused on wage growth. The ECB won't get updated wage data for the first quarter until after the April meeting, which led Lagarde to push back on the possibility of a cut by then at the conference yesterday. "We will have a little more data by April, but we will have a lot more by June," she said.
 
We also got updated forecasts from the ECB yesterday that tilted dovish compared to expectations. Not only did the ECB downgrade both its growth (0.6% from 0.8%) and inflation forecasts this year (headline forecast dropped materially from 2.7% to 2.3%), but it also downgraded inflation forecasts further out in terms of its time horizon, with core inflation in particular expected to be 2.1% by the end of next year (from 2.3% previously), before reaching 2.0% by 2026. Consensus seems to be growing within the ECB around a mid-year start to cuts, with Joachim Nagel, the hawkish president of the Bundesbank, mentioning yesterday that the ECB "could see an interest-rate cut before the summer break". 
 
Understanding when they cut first is important, and we think the ECB and the Fed are broadly matched up at the moment on when they intend to make the first move (Powell said yesterday that the Fed is “not far” from gaining that confidence). But the more important question we think is what that cutting cycle looks like after they start. 
 
Whilst we do not necessarily get this guidance from the ECB, we will get updated “dot plots” from the Fed at their meeting on March 20. The last dot plots in December had a median number of cuts this year of three, but the range was quite wide, with two members expecting zero cuts and one member expecting six. Powell in recent commentary has stated that there is no reason to think that the dot plots for this year would have changed. Whilst our base case would be for a gradual normalisation beginning in June (think three or four cuts this year), given the data so far this year (better than expected inflation, still strong growth), the risk is certainly for fewer cuts rather than more. 
 
Ultimately, the central banks have made it clear that they remain data dependent. The Fed in particular will want to see if the strong January CPI data is the start of the trend or a seasonal anomaly, although February’s nonfarm payroll data released this afternoon showed still strong labour growth (+275k with some admittedly large downgrades to previous months) but an unemployment rate that ticked up to 3.9% (from 3.7% last month) and, importantly, average hourly earnings growth of just 0.1% month-on-month versus 0.6% last month. 

So far so good for the Fed, but the real test of course comes next week with the monthly CPI data.