Vanguard: ECB cuts interest rates, market too optimistic about 2025
The ECB will cut its main policy rates by 25 basis points on Thursday, as widely signalled, and will likely follow-up with another cut in December. But a more resilient U.S. labour market and China stimulus challenges the fairly aggressive cuts priced in H1 2025. Expect Lagarde to emphasise 'data dependence' and caution against markets getting ahead of themselves.
The European Central Bank will ease monetary policy by another 25 basis points (bps) at its October meeting, which would leave the deposit facility rate at 3.25%, down 75bps from its cyclical peak. The shift to sequential, rather than quarterly, rate cuts was triggered by a deterioration in domestic activity. The PMIs for September dropped more than expected, with the composite PMI slipping below 50, whilst forward-looking surveys suggests a further loss of momentum ahead. Germany is expected to re-enter recession in H2 24, whilst employment growth is slowing below the rate anticipated by the ECB’s staff projections.
Meanwhile, the inflation data has also come in softer-than-expected. Core CPI ticked down to 2.7% year-on-year in September, whilst the sequential monthly pace (seasonally adjusted) fell more sharply. Services inflation remains elevated at 4% year-on-year, but a significant moderation in real-time wage trackers gives us confidence services price growth will normalise over the coming quarters. The weakness in the domestic data has been acknowledged by several Governing Council members, including Isabel Schnabel here.
However, since Schnabel’s speech effectively cemented the near-term rate profile, global economic momentum has taken a turn for the better. A robust September nonfarm payrolls report in the United States, coupled with monetary stimulus in China (and the promise of fiscal around the corner) now presents an upside risk to euro area growth. With markets pricing the ECB to get down to a 2% policy rate by mid-2025, expect Lagarde and the rest of the Governing Council to push against this. The ECB will almost certainly reiterate its “data-dependence” mantra and avoid endorsing the market’s fairly aggressive rate easing path.
Our view is slightly more hawkish than the market, but we’re splitting hairs. We expect the policy rate to be at 2.25% by mid-25, with the ECB skipping one meeting in H1 25.