• The ECB followed through with its well-signposted June cut, despite raising its inflation forecasts amid signs of persistent wage pressures. A back-to-back cut at the next meeting in July does not look on the cards with data out today showing that growth in compensation per employee accelerated in Q1. Further ahead the ECB will want to preserve flexibility and has no intention to set out any pre-defined path for future easing at this stage, with an emphasis that moves will be data-dependent. Nonetheless our view remains that the euro area disinflation process is set to reassert itself in the second half of the year and we suspect that the ECB’s inflation projections could be revised lower in September, clearing the path for further easing in 2024.
• Next week the focus will be on UK labour market and activity data. The official pay growth figures may look quite sticky after the 10% increase in the minimum wage in April. However, forward-looking survey data has been more encouraging and we expect further signs of easing pay pressures and labour market slack in the REC survey. On activity, monthly GDP growth is likely to be have been weaker in April but that doesn't change our expectation for a moderate expansion through the rest of the year.

ECB review: No more pre-commitment

The ECB followed through with the well-signposted cut at its June meeting, the first in almost five years, taking the key policy rate to 3.75%. Policymakers struck a cautious tone, in line with our expectations (see here), with what was a hawkish start to the easing cycle. The statement noted – somewhat contradictorily – that “the inflation outlook has improved markedly” since the last hike in September 2023 but that “domestic price pressures remain strong as wage growth is elevated, and inflation is likely to stay above target well into next year”.

This was a projection meeting and the ECB increased its inflation numbers in 2024 (headline: 2.5% from 2.3% previously, core: 2.8% from 2.6% previously). The 2025 headline number was also increased, from 2.0% to 2.2%. This was driven by expectations for stickier wage growth – the rate for compensation per employee, the ECB’s preferred measure, was revised up by 0.3pp to 4.8% in 2024. We suspect that the ECB may have had advance sight of the Q1 figures which were released today – the numbers were not good from a monetary policy perspective, with a 5.1% Y/Y increase in Q1, up from 4.8% in Q4 2023.

All told, it could be argued that the case for a cut was stronger back at the April meeting. Since then, data releases have shown higher inflation and wage growth pressures, and the ECB has found itself in the strange position of cutting rates while raising its inflation forecasts. Would the ECB have cut rates yesterday if it hadn’t essentially pre-committed to doing so? Perhaps not.

Chart 1: The ECB has revised up its inflation projections

Chart 2: Compensation per employee growth accelerated in Q1

It’s clear that the ECB has no intention to set out any specific easing schedule now. Lagarde repeatedly emphasised that policymakers will be “data dependent” and take a “meeting-by meeting” approach with an obvious intention to preserve flexibility.

That said, Lagarde did seem to dismiss the chances of back-to-back rate cuts with another move at the next meeting in July when she used the phrase “much later in the summer” during a long-winded answer about data releases.

After July, there is a summer break until the next policy meeting in September, by which time there will be a lot of fresh information. Our view remains that underlying inflationary pressures will ease. Indeed, we are below the ECB on both headline inflation (2.3% vs 2.5%) and growth (0.7% vs 0.9%) this year. There could well be a downward revision to the ECB’s inflation numbers in September which would strengthen the case for easing then. We continue to expect two further cuts this year.

Still, it looks likely that the easing cycle will be conducted against a benign macro backdrop and, in the absence of a sharp downturn or crisis, the ECB is unlikely to be in a rush to move to less restrictive levels. After telegraphing the June meeting months in advance, it seems clear that policymakers will now want to retain much more flexibility around the next move amid some signs that their confidence in the inflation outlook has become shakier.

Chart 3: Sticky services inflation is holding up the disinflation process

Chart 4: Is euro area inflation following the path seen in the US?

Next week: How sticky is UK wage growth?

The focus shifts to the UK economy next week with a range of data on the labour market and activity to be released. The official pay growth numbers could look quite sticky, with the April figures encompassing the 10% increase in the minimum wage that month. However, there are still concerns about the quality of the Labour Force Survey (the BoE noted rather pointedly that pay growth figures have “tended to be volatile” at its May meeting) which means there is extra attention paid to survey data. Next week will also see the release of the REC report on jobs, which the BoE has often cited in the past and could go some way to mitigate any concerns about sticky official pay growth figures. The latest BoE DMP survey (here) for May pointed to easing pay pressures, with the three-month average rate for expected year-ahead wage growth falling 0.3pp to 4.5%. These figures support our view that the UK disinflation trend remains on track. There were no signs of an acceleration in inflationary pressures with stable 1-year CPI inflation expectations and slightly lower output price expectations.

On activity, a slowdown is likely in the monthly UK GDP estimate for April after the strong growth recorded in March. We already know that retail sales fell sharply that month and a slight M/M contraction would not be a surprise. After the strong start to the year (0.6% Q/Q), we are tracking UK GDP growth at 0.3% in Q2, but expect a slight acceleration in the second half of the year as consumer conditions continue to improve.

In the euro area, industrial production for April will be released next week. The already-released national numbers, including a small contraction in Germany (-0.1% M/M), suggest that any growth in output will be muted.

Key data releases and events (week commencing Monday 10 June)

MUFG European Macro Outlook: Key points

• The euro area economy expanded by 0.3% Q/Q in the first quarter of the year, with all the major national economies growing at a faster-than-expected rate. The UK economy started the year strongly (0.6% Q/Q). While we look for slower growth rates in Q2, the recent uptick in momentum may well mark an inflection point after an extended period of stagnation. Broader growth conditions are set to continue to improve over coming months as real incomes recover and central banks start to ease policy.
• Nonetheless, it’s likely to be a case of moderate recovery this year rather than a rapid rebound. Monetary policy will remain in restrictive territory even after rate cuts. Meanwhile, many governments will need to make fiscal consolidation efforts after expansive spending in recent years, and structural pressures are set to continue to weigh on European manufacturing. For these reasons we do not see growth sustainably exceeding potential this year or next. We expect average growth of 1.4% in the euro area in 2025 and 1.6% in the UK.
• Despite recent upside surprises in monthly inflation figures we expect that the disinflation process will reassert itself in H2 this year. Forward-looking survey indicators point to easing price pressures, household inflation expectations are well-anchored and there are mounting signs of increased slack in labour markets. We expect annual average euro area headline inflation will ease from 2.3% in 2024 to 2.0% next year. We expect a similar path in the UK, albeit with rates remaining slightly higher (2.3% in 2024).