Next Week's Rate Cut Almost Certain, ECB to Accelerate Easing Next Year

• 2024-06-20
• News

According to a survey of economists, the European Central Bank (ECB) is expected to accelerate the pace of interest rate cuts in the coming months to stimulate the economy—reducing borrowing costs to non-restrictive levels by the end of 2025. With the current inflation rate slightly below the 2% target, economists anticipate that the ECB will lower the deposit rate by 25 basis points at each meeting next week and before March next year. Respondents predict two more rate cuts in June and December of next year, bringing the benchmark rate down to 2%.

Almost half of the respondents believe that by then, the interest rate will be at a neutral level, while about two-fifths expect the rate to be low enough to encourage economic expansion. Previous surveys forecasted that the ECB's rate-cutting cycle would end in September 2025 at 2.5%.

This shift in expectations reflects the financial market's adjustments based on economic data—macroeconomic data indicates a more unstable economy, with a faster disinflation pace in the 20 countries of the eurozone. Meanwhile, the Federal Reserve has kicked off its monetary easing policy with an unprecedented 50 basis point rate cut.

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Hugo Le Damany and Francois Cabau from AXA Investment Management said, "The ECB reaching the 2% target faster than expected is consistent with faster rate cuts in the short term. However, this does not mean they want rates below 2%, so they must manage medium-term expectations to avoid the market anticipating too many rate cuts."

Although money markets still expect the ECB to cut rates by 25 basis points next week, their confidence in further rate cuts in December has weakened. Expectations for the terminal rate have also risen, with traders now predicting that the rate will exceed 2% by the end of next year, compared to 1.75% a week ago.

Bloomberg's Senior Eurozone Economist, David Powell, said, "There is no doubt that Lagarde will be asked about the next steps at the press conference. She may continue to emphasize that the ECB is entirely data-dependent and operates on a meeting-by-meeting basis. However, the possibility of another rate cut in December seems quite high."

About two-thirds of the respondents expect the ECB to reiterate next Thursday that the Governing Council will keep policy "sufficiently restrictive" for as long as necessary to ensure inflation reaches and remains at 2% in the medium term. Although the price increase in September fell below 1.8% for the first time since 2021, officials warned that price increases will climb again in the coming months, especially with ongoing pressure in the service sector.

HSBC's Fabio Balboni said, "Given the continued high wages, a still tight labor market, and the uncertainty of service items being repriced next year, we believe the ECB will remain cautious. Although we expect the ECB to accelerate the pace of rate cuts in the next few meetings, there is still uncertainty about where inflation will land next year."

The ECB's forecast last month showed that the inflation target would be achieved in the last quarter of 2025. Since then, economists say that the risks of inflation falling below the target have begun to accumulate. 55% believe that the risk of medium-term inflation being below the target is greater than exceeding the target.

However, many respondents warned that it is not yet certain that the inflation rate can reach 2%. Although there are signs of easing in the labor market, the unemployment rate remains at a historically low level. Despite the German economy contracting for the second consecutive year, German public sector employees are still seeking an 8% pay raise, highlighting that wage pressures will not easily subside.Senior Eurozone economist at ABN Amro, Bill Diviney, stated that the European Central Bank's "main challenge remains managing the downside risks to economic growth— which have intensified— as well as the persistently rising inflationary pressures from high wage growth; however, the balance of risks seems to be distinctly tilted towards concerns about economic growth."

In fact, hopes for a recovery in household spending and investment, as well as a rebound in global trade, are fading. Most importantly, respondents believe that the largest economic risk for Europe comes from geopolitical tensions and the possibility of Trump being re-elected as President of the United States. In light of this, Andreas Koutras, Chief Risk Officer at AlphaTerra Capital, believes that the European Central Bank is "behind the curve."

Forty-nine percent of economists predict that by the end of 2025, interest rates will neither stimulate nor constrain the economy. The majority believe that the neutral interest rate— which can only be estimated and not measured— lies between 2% and 2.25%.

Economist at Scope Ratings, Dennis Shen, said that the vulnerabilities of the Eurozone economy "support the argument for accelerating the pace of easing." However, there remains "significant uncertainty" after next week. The state of the U.S. economy, actions by the Federal Reserve, the U.S. election, and escalating tensions in the Middle East that could push up energy prices will all influence the outlook for the European Central Bank's monetary policy. He said, "Inflation has not yet been conquered. This should force the European Central Bank to be cautious about its decision to cut interest rates."