Europe | Monetary Policy & Inflation | Rates
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Summary
- The ECB seems almost certain to cut 25bp at its 17 October meeting.
- Post-NFP, the market has pared expectations of cuts over the next year, but it is still pricing four 25bp cuts in as many meetings.
- While September inflation took it below ECB forecasts, we are cautious that we may be seeing a pattern of prices like that of late-2023/early 2024.
- Firms tend to reprice early in the year; an early-2025 inflation boost could quickly sap the dovish mood.
- Meanwhile, growth is not as bearish as headline suggests once we exclude Ireland (but neither is productivity). However, Germany’s headwinds cannot be ignored.
- The labour market is strong and showing little sign of weakening. That will need to change to justify pricing.
Market Implications
- ECB pricing is now more reasonable than pre-NFP. However, if the post-NFP move reverses, that would be a good opportunity to fade dovishness.
25bp Cut in October
Short of a seismic non-data surprise, the ECB will almost certainly cut interest rates by 25bps at their 17 October meeting. While ECB hawks, such as Nagel and Kazaks, have come round to an October easing, there has been little backing for a 50bp cut (gradualism remains a key talking point; even dove Centeno is against ‘big steps’). See here for our summary of recent comments.
Forecasts will remain unchanged at the 17 October meeting. As such, while September inflation decently undershot their September projections (more on that below), we expect the Governing Council will be cautious taking too much comfort from this.
We warned that 2024/25 ECB pricing was too dovish – down to 1.7% by end-2025. It has since pared to a more reasonable 2%, in reaction to the September NFP (Chart 1). Even so, four cuts at the next four meetings may still be too far if inflation reaccelerated in Q1 2025, or if the labour market remains strong.
One Inflation Miss Does Not Mean Job Done
September’s flash Eurozone inflation decently undershot ECB forecasts (Chart 2). That headline, core and services all felt the weakness suggests core services may have driven the move – accommodation prices have shown strong seasonality recently and could be a driver.
We are wary that the pattern of MoM core inflation moves is similar to 2023. Then, August (SA) came close to typical, September undershot, and October ticked back up. Similarly, wage-intensive services inflation momentum slowed through to the end of the year but picked back up in the next (Chart 3).
A similar pattern should be a concern for the EZ on the risk that inflation pressures pick back up in early 2025 (when many companies revise pricing), as they did in 2024.
Labour Market Not Yet Weakening
While inflation is undershooting ECB projections, the labour market remains stronger than forecast, driven by employment growth (Charts 4 and 5). The ECB had to improve near-term forecasts for the labour market in September, but it retains a more bearish outlook further out – these may need to be revised higher if something does not give soon. Also, notably, surveys have consistently underestimated employment growth since 2022 (Chart A5).
Productivity Problems Should Sap Dovishness
Poor economic growth has been a strong theme lately. There are several important factors to this:
- Ireland has driven an outsized part of this underperformance – excluding Ireland, growth has been outperforming versus ECB expectations (Chart 6).
- Germany is flagging other countries. In contrast, Spain is overshooting (Chart 7). Near term, it is hard to see Germany bouncing back without looser fiscal policy.
- Strong employment and weak GDP growth means labour productivity is undershooting (Chart 8).
Point 3 is important. The ECB already downgraded productivity expectations in September. If this continues, it will provide further upward pressure to the medium-term inflation outlook.
Surveys Are More Sanguine
Overall, surveys paint a relatively bearish picture, with inflation expectations re-anchoring and continued wage growth slowing ahead (Charts A2, A3, A6). However, both output and employment surveys since 2022 have tended to be more bearish than hard data (Charts A4, A5).
Recent Policy Maker Comments
(The commentary contained in the above article does not constitute an offer or a solicitation, or a recommendation to implement or liquidate an investment or to carry out any other transaction. It should not be used as a basis for any investment decision or other decision. Any investment decision should be based on appropriate professional advice specific to your needs.)