Economists anticipate that the European Central Bank (ECB) will not formally alter its policy guidance this week, nor do they expect President Lagarde to correct expectations regarding faster rate cuts.
The ECB is set to conduct its third rate cut this year in Thursday's meeting, as policymakers have indicated that inflationary risks are easing at a faster-than-expected pace.
The eurozone's overall inflation rate for September fell to 1.8%, already below the bank's 2% target. Core inflation rate dropped to 2.7%, marking the lowest level in two and a half years.
These figures continue to decline overall after the ECB reduced interest rates by 25 basis points in June and again by 25 basis points in September, bringing the key rate—the deposit facility rate—from a record high of 4% to 3.5%.
Currently, not only does the money market price a 25 basis point rate cut for the ECB's October meeting, but it also anticipates a 50 basis point rate cut at the December meeting, which is the last one for the year.
Since the ECB's September interest rate meeting, the market's expectations for faster easing have been on the rise due to a series of dovish statements by officials, as well as inflation data from eurozone countries (including Germany) that have come in below expectations. Banque de France Governor Francois Villeroy de Galhau stated last week that a rate cut in October is "highly likely" and that it "won't be the last."
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Villeroy, in an interview with France's news radio, said, "Victory over inflation is within sight," noting that the inflation rate may experience some fluctuations and increases.
ECB President Christine Lagarde told Members of the European Parliament at the end of last month that the latest developments have strengthened the bank's "confidence that inflation will fall back to target levels in a timely manner" and that this will be taken into consideration in October. Citigroup analysts described this signal as a "shift" from Lagarde's message on September 12th, when she suggested that a "gradual" approach to rate cuts would be more appropriate given the risks to the inflation outlook.
Even the ECB's well-known hawk, Bundesbank President Joachim Nagel, indicated earlier this month that the inflation trend is "good news," and he is open to discussing further rate cuts.Weak Growth
The continued sluggish economic activity in the Eurozone, along with the Federal Reserve's decision on September 18th to continue lowering interest rates by 50 basis points, has also increased expectations for the European Central Bank (ECB) to continue cutting interest rates.
Barclays strategists stated in a report on Sunday, "Significantly weaker activity data and a faster disinflation process have had a direct impact on the ECB's communication and the market."
According to consulting firm Capital Economics, the composite Purchasing Managers' Index (PMI), which measures activity in the services and manufacturing sectors, indicates that the Eurozone economy stagnated in the third quarter, with only a 0.3% growth in the second quarter.
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 has led him to predict that the ECB will cut interest rates at this week's meeting and at every future meeting until the deposit rate reaches 2.5%.
He added that this expectation also stems from the cooling labor market and the slowdown in wage growth, which will help to reduce service sector inflation in the coming months.
Last month, against the backdrop of weak domestic demand, the ECB downgraded its forecast for Eurozone economic growth for the year, currently expecting GDP to grow by 0.8%, compared to the previous forecast of 0.9%.
Rhetoric Adjustment
Economists at Bank of America Global Research stated in a report on Sunday that they expect the ECB to cut interest rates this week but do not anticipate any significant adjustments to its guidance.They stated, "We believe this marks the beginning of an accelerated trajectory to reduce interest rates to 2% by June 2025 and further to 1.5% by the end of 2025. However, it is highly unlikely that the European Central Bank (ECB) will communicate any such message. Decision-making on a meeting-by-meeting basis and data dependency are likely to continue to dominate strongly, perhaps only embellished with verbal mentions of increased confidence in the return of inflation to target."
Berenberg's Chief Economist, Holger Schmieding, said that Lagarde is unlikely to correct the market's expectations for a rate cut in December during Thursday's press conference. He forecasted that the ECB might have to further downgrade its economic growth forecast for 2024 when it releases new staff projections in December.
However, Schmieding also warned of the risks of the ECB overreacting and easing monetary policy too quickly.
In a report on Monday, he stated, "Next year, inflation should not be the main issue... However, we believe that this situation will not persist in 2026 and 2027."
He believes that once the economic growth rate in 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 reduces the deposit rate to a level far below 3% by 2025, it may have to raise it back to 3% by the end of 2026 or the beginning of 2027."