European Central Bank: Data-dependent ECB cuts 25bps after downward data surprises

The economist view – Melanie Baker, Senior Economist

As was widely expected, the European Central Bank cut rates 25 basis points with the deposit rate now at 3.25%. Activity data had cooled of late and inflation surprised on the downside. In the build-up to the meeting, a number of ECB speakers had indicated that a rate cut was on the table for this meeting.

The ECB expect inflation to rise in coming months but then decline next year as labour cost pressures ease and profits act as a buffer for the impact of wages on inflation. The incoming data gave them confidence that inflation is on track for a sustainable 2% outcome.

Not giving much away

The key guidance language from the ECB was unchanged, indicating a continued meeting-by-meeting, data-dependent approach and where they are not pre-committing to a particular rate path. So, yet again, they gave little away in that sense about the likely path of rates in coming months. By keeping the language around keeping policy rates “sufficiently restrictive for as long as necessary” and from Lagarde’s comments, it is clear that they do still see policy settings as restrictive. For now they see that as necessary (by Lagarde’s analogy, they haven’t yet ‘broken the neck’ of inflation (!)). So, while there is no pre-commitment here, it makes sense to assume that the ECB will want to continue making interest rates less restrictive, so long as underlying inflation trends and the evolving outlook keep giving them encouragement to do so.

Why cut today and why not 50bps?

Lagarde painted a picture where the data since the last meeting pointed in the same direction (downwards), giving them more confidence that the disinflationary process was “well on track.” Activity data has been somewhat weaker than expected and in an answer to a question she singled out PMI business surveys for example and the inflation data: “all the information were heading in the same direction.” She was asked directly why they didn’t cut 50bps. She said that the proposal was 25bps “end of story” and the vote unanimous.

Lagarde again stressed that they are not datapoint dependent– it was about an array of information and data. She said that there was no question in their mind that they are currently restrictive in terms of monetary policy.

December meeting – data and forecast dependent

There was limited signalling around the ECB’s next meeting in December, but Lagarde did note that there will be a full projection exercise done for that meeting and that they will get more data by then. They are expecting inflation to rise on a variety of base effects, so an increase in headline inflation won’t come as a surprise in and of itself. Lagarde again stressed that they are not datapoint dependent– it was about an array of information and data. She said that there was no question in their mind that they are currently restrictive in terms of monetary policy. She also talked about there being no question that they are not yet at the 2% inflation target in terms of this being sustainable. Add all that together and another cut in December looks a sensible central case, but will depend on the data between then and now supporting a continued build in confidence that inflation is heading in the right direction.

3.25% is still some way above a likely medium-term neutral rate for the euro area (likely closer to 2% in my view), so there is still ‘room’ to cut in that sense. However, there is enough uncertainty around the outlook and where neutral is that it isn’t a given we will see the ECB cut at consecutive meetings from here.

The government bond manager view – Gareth Hill, Senior Fund Manager

Just five short weeks ago, at the previous meeting of the ECB’s Governing Council, the messaging from the ECB was clear – the prospect of consecutive cuts to its interest rates was, at best, unlikely. President Lagarde warned against reading too much into any specific datapoint and even flagged that they expected further weakness in the September inflation data.

Fast forward to October 17th’s meeting, and a further 25bps cut in interest rates was fully priced, and the ECB duly delivered on this – so the challenge faced by Lagarde was how to pitch this rate cut and preserve credibility going forward. The approach taken was to use this as an example of their data (not data point) dependent, meeting by meeting, no predetermined path approach to monetary policy easing. Lagarde pointed to weaker than anticipated PMI data, coupled with incoming inflation disappointing to the downside, meaning that the Governing Council was unanimous in its decision to cut rates. However, she was also at pains to stress that the market should not read anything into consecutive cuts and, when asked by a journalist in the accompanying press conference, swiftly dismissed the notion of a larger 50bps cut to its key interest rates. A European recession is not currently in their thinking and they are alert to the risk to inflation and growth of any potential tariffs that could result from a Trump victory in next month’s US Presidential election.

The market is currently pricing close to five further cuts by June 2025, potentially taking the deposit rate to 2%, from its current 3.25%.

Despite this, the market is currently pricing close to five further cuts by June 2025, potentially taking the deposit rate to 2%, from its current 3.25%. Whilst this rate path may seem somewhat aggressive, the last five weeks serves to demonstrate that in current markets, combined with the potential of deteriorating incoming data and the ECB doubling down on a data dependent approach, the possibility cannot be entirely ignored. However, the tight US election race cannot be ignored either and the various potential outcomes (in terms of the President and make-up of the House) will not only determine US policy but also have implications on Europe and the ECB too.

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