European flags waved in front of the European Central Bank (ECB) building before a news conference following the ECB governing council meeting in Frankfurt, Germany, on September 12, 2024, captured in an image by Daniel Roland from AFP via Getty Images.
The European Central Bank is expected to implement its third interest rate cut of the year during its meeting this Thursday, as policymakers indicate that inflation risks are diminishing more quickly than anticipated. In September, headline inflation in the euro area declined to 1.8%, falling below the central bank’s target of 2%. Core inflation, excluding energy, food, alcohol, and tobacco, dropped to a two-and-a-half-year low of 2.7%.
These inflation figures have continued to decrease even after the ECB reduced interest rates by 25 basis points in both June and September. These cuts have lowered the central bank’s key rate, the deposit facility, from a record high of 4% to 3.5% over the two sessions. As of Monday morning, money markets had anticipated another 25-basis-point reduction in the October meeting, followed by a cut to 3% in the ECB’s final meeting of the year in December.
Expectations for accelerated monetary easing have grown since the ECB’s September 12 meeting, spurred by dovish comments from officials and lower-than-expected inflation figures from euro area countries, including Germany. Last week, Bank of France Governor François Villeroy de Galhau indicated that a rate cut in October is “very likely” and suggested that it may not be the last. He mentioned in a France Info interview that the achievement against inflation is near but acknowledged potential volatility and increases in headline rates.
ECB President Christine Lagarde informed European Union parliamentarians late last month that recent developments had increased the central bank’s “confidence that inflation will return to target in a timely manner,” which would be considered in October. Analysts at Citi noted this as a shift away from Lagarde’s earlier position on September 12, which recommended a “gradual approach” to rate cuts due to potential inflation risks.
Joachim Nagel, head of Germany’s Bundesbank and known for his hawkish stance, mentioned to Table Media earlier this month that the inflation trend was “good news” and expressed openness to discussing another rate cut.
Meanwhile, expectations for consecutive rate cuts have also been fueled by continued sluggishness in euro area economic activity and the course set by the U.S. Federal Reserve’s decision on September 18 to implement a 50-basis-point rate reduction. Barclays strategists noted that weaker activity data and faster disinflation have impacted both ECB communication and market sentiment.
Composite purchasing managers’ index data, which evaluate services and manufacturing activity, indicate stagnation in the third quarter, according to Capital Economics. This follows a modest 0.3% growth in the second quarter, with a preliminary reading for the third quarter expected on October 30.
Jack Allen-Reynolds, Capital Economics’ deputy chief euro zone economist, remarked last week that tight monetary policy is hindering growth and coupled with structural issues like the decline in German industrial competitiveness. He forecasts that the ECB will conduct rate cuts at its upcoming meetings until the deposit rate reaches 2.5%. This outlook also takes into consideration a cooling labor market and slower wage growth, which are expected to help reduce services inflation in the coming months.
Last month, the ECB lowered its annual growth forecast for the euro zone to 0.8%, down from 0.9%, due to weaker domestic demand.
Bank of America Global Research expressed in a Sunday note that the ECB is anticipated to cut rates this week without significant adjustments to their guidance. They interpret this as the beginning of an accelerated trajectory toward a 2% rate by June 2025, with a further decline to 1.5% by the end of 2025. However, they noted that the ECB is unlikely to convey any definitive plans and will likely maintain a meeting-by-meeting approach and data dependence.
Holger Schmieding, Chief Economist at Berenberg, suggested that Lagarde is unlikely to alter market expectations for a December cut at her press conference on Thursday, thereby solidifying the existing pricing. He predicted the ECB might have to further reduce its 2024 growth outlook in December and warned of the risk of overreacting with overly aggressive and rapid monetary policy easing.
Schmieding stated that while inflation might not be a major issue next year, the concern could resurface in 2026 and 2027. He argued that as the euro area’s growth normalizes by spring next year, as expected by the ECB, wage inflation will rise, and stronger demand will allow companies to transfer increased costs to consumers. He projected that if the ECB reduces the deposit rate below 3% by 2025, it might need to raise it back to 3% by late 2026 or early 2027.
