The European Central Bank (ECB) is set to announce its third interest rate cut this year at its meeting on Thursday. Policymakers have indicated that the easing of inflation risks is happening faster than previously anticipated.
In September, the overall price increase in the Eurozone fell to 1.8%, below the central bank's 2% target. Core inflation, which excludes more volatile components such as energy, food, alcohol, and tobacco, stood at 2.7%, reaching a two-and-a-half-year low.
Despite the ECB's interest rate cut of 25 basis points in June and another 25 basis points in September, these figures continued to decline, with the central bank lowering its key interest rate—deposit facility—from a record 4% to 3.5% during the two meetings.
As of Monday morning, the money market had already priced in the expectation that the Federal Reserve would cut rates by another 25 basis points at its October meeting, as well as the expectation of a rate cut to 3% at the next and final meeting of the year in December.
Since the ECB meeting on September 12th, expectations for accelerated monetary easing have been growing stronger, with officials making a series of dovish remarks, including inflation data in Eurozone countries such as Germany that have fallen short of expectations. Banque de France Governor François Villeroy de Galhau stated last week that the possibility of a rate cut in October is "very high" and that it "won't be the last one."
"Victory over inflation is within sight," Villeroy said to France Info radio, noting that some fluctuations and an increase in overall inflation rates could follow.
ECB President Christine Lagarde told EU lawmakers at the end of last month that the latest developments have strengthened the ECB's "confidence that inflation will return to target levels in a timely manner," and that this would be taken into account in October. Citigroup analysts described this signal as a "pivot" away from Lagarde's speech on September 12th. Lagarde's speech on September 12th suggested that a "gradual approach" to rate cuts would be more appropriate, considering the risks to the inflation outlook.
Even the ECB hawk and Bundesbank President Joachim Nagel told Table Media earlier this month that the inflation trend is "good news," and that he is willing to discuss another rate cut.
Weak economic growthThe ongoing sluggishness of economic activity in the Eurozone, coupled with the Federal Reserve's decision on September 18th to continue lowering interest rates by 50 basis points, has also heightened expectations for consecutive rate cuts.
Barclays strategists stated in a report on Sunday: "It is clear that softening economic activity data and accelerating deflation have had a direct impact on the European Central Bank's communication and the market."
Consultancy firm Capital Economics indicated that the composite Purchasing Managers' Index (PMI) data, which measures activity in the service and manufacturing sectors, shows stagnation for the third quarter. This follows a lackluster growth of 0.3% in the second quarter.
The preliminary values for the third quarter will be released on October 30th.
Jack Allen-Reynolds, Deputy Chief Eurozone Economist at Capital Economics, stated last week that, in addition to structural issues such as the decline in German industrial competitiveness, tight monetary policy is also dragging down economic growth. This leads him to predict that the European Central Bank will cut interest rates at this week's and upcoming meetings until the deposit rate reaches 2.5%.
He added that this outlook is also due to the cooling labor market and slowing wage growth, which help to reduce service sector inflation in the coming months.
Last month, due to weak domestic demand, the European Central Bank itself downgraded its forecast for annual economic growth in the Eurozone, now expecting Eurozone GDP to grow by 0.8%, compared to the previous forecast of 0.9%.
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Economists at Bank of America Global Research said in a report on Sunday that they expect the European Central Bank to cut interest rates this week without making significant adjustments to its guidance.
They said: "In our view, this is the beginning of an acceleration trajectory, reaching 2% by June 2025, and further reaching 1.5% by the end of 2025.""However, the European Central Bank is unlikely to convey such a message. This approach of meeting after meeting and dependence on data may remain unchanged, perhaps only (verbally) mentioning that confidence in inflation returning to target levels is strengthening."
Berenberg Bank's Chief Economist Holger Schmieding stated that Lagarde is unlikely to revise market expectations for a rate cut in December during Thursday's press conference, thereby locking in prices. Schmieding predicts that the ECB may have to further lower its growth forecasts for 2024 when it releases new staff projections in December.
However, he also warned that there is a risk of the central bank overreacting and easing monetary policy too much and too quickly.
"Next year, inflation should not be a major issue... however, in our view, this situation will not last until 2026 and 2027," he said in a report on Monday.
He believes that once the growth rate of the eurozone returns to normal next spring as expected by the ECB, wage inflation will rebound, and stronger demand will enable businesses to pass on higher costs to consumers.
Schmieding said: "If the ECB lowers the deposit rate to a level far below 3% in 2025, then it may have to raise it to 3% by the end of 2026 or the beginning of 2027."
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