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Morning Bid: ECB may stumble into stimulus

FILE PHOTO: A view of European Central Bank headquarters in Frankfurt, Germany · Reuters

A look at the day ahead in U.S. and global markets.

World markets are entering March with Friday’s alarming Oval Office row reverberating on both sides of the Atlantic, raising more questions about increasingly unpredictable geopolitics just as investors are also turning anxious about a potential economic slowdown. Tuesday’s U.S. tariff deadline, labor market updates and China’s National People’s Congress will all jockey for attention this week. But the European Central Bank’s likely interest rate cut on Thursday is today’s spotlight.

TODAY’S MARKET MINUTE

• European leaders including the UK have joined forces to draft a peace plan for Ukraine to present to Trump.
• Bitcoin has surged more than 20% from last week’s lows, along with several other cryptocurrencies after Trump hints at the creation of a new U.S. strategic reserve.
• U.S. House Speaker Mike Johnson says he wants a “clean” stopgap funding measure to keep federal agencies operating.
• Commerce Secretary Howard Lutnick says tariffs on Canada and Mexico will go into effect tomorrow, but Trump will determine whether to stick with the planned 25% level.
• Parties in talks to form Germany’s new government are considering quickly setting up two special funds – potentially worth around 400 billion euros ($415 billion) for defense and 400 billion to 500 billion euros for infrastructure, sources told Reuters.

ECB MAY FEAR STUMBLING INTO STIMULUS

Few doubt the European Central Bank will cut interest rates again this Thursday, but there are fears in the ECB ranks that easing much further after that may see it inadvertently stumble into stimulative territory before inflation has been licked. Much like its peers around the world, the ECB is due to review policy again and issue a series of long-term forecasts even though it barely knows what the economic or political backdrop will be next month. Uncertainty about potential U.S. tariffs, the identity of the new German government, the fate of Ukraine and a likely new public spending boost to re-arm the continent are all fogging up ECB eyeglasses considerably.

Further complicating things is the fact that several critical macroeconomic inputs used to assess the ECB’s inflation outlook have been swinging back and forth wildly this year. Take European natural gas prices. From the middle of January, they rocketed about 30% higher, only to reverse all that by the middle of last month.

The macro mist simply forces the central bank to seek other lodestars to guide its policy deliberations, and hence its recent obsession with the much-maligned and nebulous ‘neutral’ interest rate concept. So-called R*, the interest rate present when an economy is at full employment with stable inflation, is highly dependent on model assumption and impossible to identify in real time. But this theoretical figure at least offers policymakers some idea of whether existing policy is restrictive or stimulative.

There’s little doubt among ECB members that current rates are now above that neutral rate and still ‘restrictive’, which is why there is likely to be agreement on another cut this week. But the hawks among them may make a stout defense for more caution from April onwards, pointing to the slipperiness of R*.

ECB economists last month took another stab at capturing this elusive beast and put the policy rate associated with the real R* in a 1.75%-2.25% range. The centerpoint of that is roughly where most policymakers had assumed R* to be. But the range is quite important for financial markets, as the two ends of the range represent the difference between four more cuts or just two from today’s 2.75% deposit rate.

ECB board hawk Isabel Schnabel’s typically detailed and data-packed speech in London last week laid out a case for being wary of excessive easing due to the elusiveness of the enigmatic R. The gist of her talk was that incoming lending data had cast doubt on how tight ECB policy actually is, meaning continual easing to address structural GDP weakness may be misguided. And she concluded that uncertainty about just how high R had risen of late meant there was a risk that the central bank would unintentionally lapse into stimulative monetary policy.

That, she said, was related to geopolitical supply shocks, rising public debt and withdrawal of central banks from bond markets as they reduced their balance sheets. If she’s right, then the ECB may need to tread very carefully after this next cut. Especially if she’s correct that higher public debt is a significant factor in the R* debate, as there’s little doubt that’s about to ratchet higher if Europe truly does re-arm. The doves will fight back, of course, but the central banking battle lines are being drawn.

CHART OF THE DAY

After a sweep of