European Central Bank set for third interest rate cut of the year in meeting this week
European flags flutter in front of the European Central Bank (ECB) building prior to a news conference following the meeting of the governing council of the ECB in Frankfurt/Main, Germany, on September 12, 2024. Daniel Roland | Afp | Getty Images
The European Central Bank is on course to deliver its third interest rate cut of the year at its meeting this Thursday, as policymakers say inflation risks are easing faster than previously expected. Headline price rises in the euro area cooled to 1.8% in September, below the central bank's 2% target. Core inflation, which strips out the more volatile components of energy, food, alcohol and tobacco, hit a two-and-a-half year low of 2.7%. Those figures have broadly continued to fall even after the ECB cut interest rates by 25 basis points in June, and again by the same amount in September, with the central bank taking its key rate ? the deposit facility ? from a record high of 4% down to 3.5% across the two sessions. As of Monday morning, money markets had priced in not only another 25-basis-point reduction during the October meeting, but also a follow-up cut to 3% at its next and final gathering of the year in December. Expectations for faster monetary easing have built since the ECB's Sept. 12 meeting, amid a series of dovish comments from officials and cooler-than-expected inflation prints from euro area states, including Germany. Bank of France Governor Francois Villeroy de Galhau last week described an October rate cut as "very likely" and said such a step "won't be the last." "Victory against inflation is in sight," Villeroy told radio station France Info, noting that some volatility and upticks in the headline rate could follow.
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ECB President Christine Lagarde told European Union parliamentarians late last month that the latest developments had strengthened the central bank's "confidence that inflation will return to target in a timely manner," and said this would be taken into account in October. Analysts at Citi described this signal as a "pivot" away from Lagarde's Sept. 12 messaging, which suggested a "gradual approach" to rate cuts was more appropriate, given risks to the inflation outlook. Even noted ECB hawk Joachim Nagel, head of Germany's Bundesbank, told Table Media earlier this month that the inflation trend was "good news" and that he was open to discussing another cut.
Weak growth
Expectations of back-to-back cuts have also been raised by the continued sluggishness in euro area economic activity, as well as by the tone set by the U.S. Federal Reserve's Sept. 18 decision to press ahead with a 50-basis-point rate reduction. "Clearly softer activity data and faster disinflation have had an immediate impact on both ECB communication and markets," Barclays strategists said in a note Sunday. Composite purchasing managers' index figures, which measure services and manufacturing activity, point to stagnation in the third quarter, according to consultancy Capital Economics. That would follow tepid 0.3% growth in the second quarter. A flash reading for the third quarter will be released on Oct. 30.
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Tight monetary policy is providing a drag on growth, in addition to structural issues such as the decline in German industrial competitiveness, Jack Allen-Reynolds, Capital Economics' deputy chief euro zone economist, said last week. This led him to forecast ECB rate cuts will take place both this week and at each of the central bank's forthcoming meetings, until the deposit rate hits 2.5%. That outlook is also due to a cooling labor market and slower wage growth helping bring down services inflation in the months ahead, he added. The ECB itself trimmed its annual euro zone growth forecast last month on the back of weaker domestic demand, now projecting an 0.8% GDP rise, compared with 0.9% previously.
Adjustment in language
Economists at Bank of America Global Research said in a Sunday note that they expected the ECB to cut rates this week without making major changes to their guidance. "In our view, this is the start of that accelerated trajectory to 2% [rates] by June 2025 and further to 1.5% by end-2025," they said. "However, the ECB is very unlikely to communicate anything of the sort. The meeting-by-meeting approach and data dependence are likely to remain firmly in place, perhaps just sprinkled by (verbal) references to rising confidence that inflation is on track to return to target."
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