The European Central Bank cut its deposit facility rate by 25 basis points (bp) on 12 September, as widely expected. The deposit rate, which has gained the status of the ECB’s main interest rate, i.e., the rate through which it steers monetary policy, now stands at 3.50%. What can we now expect from the ECB given the latest comments and projections?
The main refinancing operations (refi) rate now stands at 3.65% and the marginal landing facility rate at 3.90%. As the ECB announced in March, the so-called corridor between the refi rate and the depo rate has been narrowed to reduce volatility in money market rates.
As was widely expected, due to the reluctance of many Governing Council members to make commitments on the future path of policy rates, President Christine Lagarde gave no forward guidance. ‘We are going to decide meeting-by-meeting’ is the ECB’s new mantra.
However, President Lagarde did mention during her press conference that there is a ‘relatively short time’ before October’s policy meeting. This could be interpreted as a subtle way of suggesting that even if ‘every meeting is a live meeting’ (another central bank mantra), the council meeting on 17 October may end up being different.
As usual, sources familiar with the situation said that the ECB is ‘not yet in a position’ to rule out a cut in October. Futures markets adjusted their expectations during the ECB press conference and after these comments by the ECB president. At the end of the day, they reflected a probability below 50% of a cut in October and a total of 40bps of rate cuts between now and the end of the year.
A 25bp cut in December now appears the most likely option for the ECB. In the meantime, debate on the magnitude of a rate cut expected from the next Federal Reserve policy meeting on 18 September is still raging.
What will be the pace of further moves?
In fact, the latest set of ECB staff projections (see table below) could justify a more aggressive cuts since GDP growth was revised down. The ECB could also argue for quarterly rate cuts since core inflation was revised up slightly. The projections now point to headline inflation at 2.0% by the end of 2025 and core inflation (excluding energy and food) at the ECB’s target of 2% in Q2 2026.
Nevertheless, and even if the ‘risks to growth are skewed to the downside’, the general tone of Ms. Lagarde’s comments was rather optimistic on growth (‘recovery is expected to strengthen’, ‘labour market is resilient’). The ECB appears confident that inflation will be back to target (‘unit labour costs are expected to continue to decline’).
Besides, by saying that the ECB ‘needs to be attentive to the risk of below target inflation’, Ms. Lagarde gave a clear hint, echoing comments by Federal Reserve Bank of San Francisco’s Mary Daly about the risk of excessively tight monetary policy when rising ‘real rates of interest meet a slowing economy’. There may be no urgency to cut, but surely a necessity to keep on cutting.
