Peter Schaffrik:
Welcome back to European Markets. Today is the 18th of June, 2024, and my name is Peter Schaffrik. Today I'd like to talk about two things. First, about the ECBs quite hawkish rate cut and secondly, about the going ons in the French bond market and whether or not that has any bearings on the ECB.
Quick sneak preview: we don't think so, but let's look into it. First of all, the ECB has cut rates as we expected, as the market was expecting, and frankly, as everyone was expecting. However, the messaging that came long with it was considered to be relatively hawkish and the bond market at the time sold off. They left any further guidance about what's coming afterwards out. They reduced what is called the de-easing bias in the statement indicating that rates would be cut further. They left that out and they also downplayed in the Q and A, a lot of the things that they previously stressed, such as, for instance, the wage developments or other indicators. We still think that they will cut rates again in September.
However, we think the situation is not as clear cut. So why did they deliver a relatively hawkish statement? We have been stressing for quite some time that the inflation dynamics are not as benign as the ECB would like to see. The chart that you're currently looking at shows, again, headline inflation, which is falling, but also service inflation, which remains elevated and in fact is hovering around 4% for quite some time now. This is not good enough, we think, over the more medium term for the ECB, particularly when you throw into the equation that PMIs are recovering, that wages stay elevated and that real wages are now turning positive and thereby boosting consumption.
This is a backdrop that should keep particularly the domestically generated part of the inflation basket elevated, unless the ECBs strong assumption about productivity growth comes to fruition. However, we have our doubts. The chart that you're currently looking at shows the ECBs forecasts for productivity growth. So how much can we produce with the same amount of resources? And as you can see, these forecasts imply productivity growth at the peak compared to the last 10, 12 years. We think that is quite optimistic. Yes, as the economy recovers, we probably will see some kind of productivity growth because that's typically what happens.
However, whether we can have that kind of lift that the ECB is forecasting, we think is much more doubtful. And if that's not the case, we also think it's quite plausible that wages will stay more elevated than the ECB thinks, and ultimately the pass through into CPI is also going to be higher than what the ECB is expecting. So therefore, again, yes, we think the ECB will cut rates again in September, probably in December too. Anything thereafter remains more doubtful and on balance, we still think that the ECB is probably going to deliver less than what the market is currently implying. However, I'd also like to talk about the second big topic in the market these days: the fallout from the European election and the announcement of the French assembly elections.
The chart that you're currently seeing shows a quite significant widening of French spreads relative to Germany, but also others here depicted by the BTP spread, the Italian spread. Now, quite some people have already asked whether that triggers ECB intervention or maybe quicker rate cuts. We don't think so. First of all, we think the backdrop for France was quite difficult to begin with. Debt levels are relatively high at about 110%. The budget deficit is quite wide, particularly against the backdrop that the economy has been performing quite well, five and a half percent.
And against that, the pricing in the market was probably too tight to begin with. We think it's more likely that the market is repricing France from, let's call it a weak core country, to a strong peripheral country, which requires higher spreads over the more medium term. ECB officials have already said that they don't think the situation warrants intervening and that they would like to see the situation play out in the market. We think they've got a point. When you look at the next chart, it shows the absolute yield level, not the spread level, the absolute yield level of French.
They have barely moved, and this is obviously the most important metric when it comes to financing the state. So yes, France might have to live with longer term higher spreads relative to other countries in the Euro area, but other countries have done that for years, and we don't think that this situation at the moment is so threatening that the ECB would feel obliged to intervene. And with that, I thank you for watching and I hope you're going to join us again next time.