The ECB may accelerate its rate-cutting cycle if French developments tighten financial conditions, according to Bank of America.
ADVERTISEMENTBank of America predicts that the European Central Bank (ECB) might accelerate its interest rate cuts if the French elections lead to increased market risks.
"The main risk from here is whether French developments end up leading to a persistent tightening of financial conditions and a sustained uncertainty shock," Bank of America economist Ruben Segura-Cayuela wrote in a recent note.
Bank of America cautions that larger shocks from the French elections could lead to weaker Euro area growth, faster disinflation, and a more rapid ECB rate-cutting cycle.
Bank of America’s euro area outlook
While the overall eurozone economy behaved largely as expected, variations across member states were evident, according to Bank of America.
The investment bank has revised euro area growth forecasts for 2024 slightly higher from 0.5% to 0.6%. However, this overall figure masks a downward revision for Germany, counterbalanced by stronger-than-expected growth in Italy and Spain. Instead, eurozone growth for 2025 has been downwardly revised from 1.2% to 1.1%.
“The underlying growth picture remains one of weak, but slowly improving, growth,” Ruben Segura-Cayuela said.
Looking ahead, the key themes for the block remain unchanged: real income recovery should support consumer spending, but much of the positive surprises ahead will likely stem from global economic improvements.
Segura-Cayuela notes that the US economy has consistently outperformed the euro area in terms of growth and inflation, a trend likely to continue. This divergence is critical as it underscores differing monetary policy trajectories between the Federal Reserve and the ECB.
Bank of America maintains that inflation will likely reach its target by early 2025 but warns of a persistent undershoot thereafter, driven by weaker energy prices. The institution's forecasts for headline inflation stand at 2.3% for 2024 and 1.5% for 2025, with core inflation expected to be 2.5% in 2024 and 1.8% in 2025.
“We still think the chronic insufficiency of aggregate demand and a persistent output gap that will not close even by 2026, together with an overly tight policy mix, will all contribute to the undershoot,” Segura-Cayuela commented.
Implications for ECB rate cuts and uncertainties from French elections
In its analysis, Bank of America anticipates a total of 75 basis points of ECB rate cuts in 2024 (with 25 basis points already delivered in June) and 125 basis points in 2025.
The data trends suggest that the ECB may need to expedite its rate-cutting cycle more than currently expected, aiming for a deposit rate of 2% by the second half of 2025.
The ECB's easing cycle, which began in June, is projected to be slightly more protracted. Initial cuts are expected every other meeting by 25 basis points, transitioning to cuts at every meeting starting in March 2025.
However, “if developments in France deliver a persistent tightening of financial conditions across the region, that could still easily bring the acceleration of the cutting cycle to late 2024,” Segura-Cayuela warned.
Bank of America's long-term view suggests that rate cuts are likely to continue beyond 2025. The neutral rate is believed to be below 2%, akin to pre-pandemic levels. However, the 2% rate will be a critical pause point for the ECB until data confirms that this rate remains restrictive.
Overall, Bank of America's analysis suggests that the ECB in Frankfurt stands ready to expedite rate cuts if market conditions worsen due to heightening political risks, aiming to mitigate rising fragmentation risks within the Eurozone.
