ECB opens door to faster pace of cuts

The ECB cut its key policy rates by 25bp at the October Governing Council meeting as was widely expected. The commentary in the statement and in the press conference suggests that the Governing Council is in the process of re-assessing the outlook for growth and inflation downwards, though this will only come to a head at the December meeting, when the staff will update the central bank’s projections. President Christine Lagarde noted that ‘we will determine what is the best rate, what is the best speed, how far, how deep we have to go to return inflation to its 2% medium-term target. This is what we will do in December’. Two important developments had triggered the October rate cut as well as the re-assessment of the extent of rate cuts going forward. First of all, the Governing Council judged that ‘the inflation outlook is (…) affected by recent downside surprises in indicators of economic activity’.

This was confirmed by a range of business surveys, including seemingly the ECB’s telephone survey. Second of all, ‘the incoming information on inflation shows that the disinflationary process is well on track’. Not only had the headline decline to 1.7% surprised the ECB, but the details were encouraging with the 3mo3m rate of services inflation falling significantly between August and September (from 4.4% to 3.9%). The latter is particularly important given the ECB’s focus on domestic inflationary pressures. In the Q&A, Ms. Lagarde noted that the risk to inflation is now more to the downside than the upside. Finally, the ECB considers that ‘financing conditions remain restrictive’, which signals that there is significant room for policy rates to decline further.

Following the dovish commentary, the chances of the ECB stepping up the pace of rate cuts with a 50bp move in December has increased. Indeed, markets are pricing in 37bp of rate cuts at that meeting currently. For that to materialise, business surveys would need to remain stuck at levels consistent with stagnant growth. This would place further doubt on the ECB’s current projections that the economy would expand at 0.2% qoq pace in H2, but perhaps more importantly on their expectation for an acceleration in the pace of growth next year (to around 0.4% qoq). In addition, although headline annual rates of inflation are set to increase, we would need to see further convincing progress in terms of services inflation. A promising development on that front is that wage disinflation appears to have resumed, with the Indeed monthly tracker (out today) falling a full percentage point to 3.1% y/y in September – the lowest since January 2022. Whether or not the ECB steps up the pace in December, we stick to our view that policy rates will be cut more significantly than markets currently price next year, to a trough of 1.5%. For now we stick to our view that the ECB will cut rates by 25bp until they reach that level. See our September Monthly for more on the eurozone outlook.