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Summary
- The ECB is widely expected to cut its depo rate by another 25bps on Thursday.
- Below-target inflation and increasing signs of economic, and in particular labour market, weakness are why.
- But we expect a cautious tone given inflation is set to rise again in Q4, risks over January repricing remain, and Q2 employment growth was above ECB forecasts.
Market Implications
- Market pricing of four cuts over the next four meetings looks reasonable, assuming inflation reacceleration is mild and labour market weakness continues.
- Yet ongoing concerns over services inflation and a lack of hard data on the extent of the macro slowdown suggest caution.
- We look to fade any increased dovishness in the near term unless justified by a tangible shift in ECB tone or data.
Switching to a Meeting-by-Meeting Easing Cycle
Below-target inflation, a softening labour market and continued deterioration in survey data all suggest a third rate cut from the ECB this week. The ECB will likely maintain its data-dependent and gradual approach to easing despite the move away from earlier expectations for a quarterly cutting cycle. But the overall tone of the press conference should determine whether successive rate cuts are indeed likely.
September CPI – Below Target But Not Below Forecast
ECB commentary has almost uniformly turned more dovish since the last policy meeting. That September’s flash CPI was below target at 1.8%, PMI readings weakened further and labour market conditions look to be deteriorating have swayed the ECB hawks.
As such, the absence of updated forecasts this month (or much hard data) will no longer prevent further policy loosening. And markets have almost fully priced a 25bp cut to 3.25% for Thursday’s meeting. But we caution that pricing further out remains dovish. The ECB expects inflation will accelerate in Q4 on unhelpful base effects for energy prices. Meanwhile, we continue to flag a potential uptick in inflation in Q1 if firm repricing follows early 2024 patterns.
The governing council will have the detail on September inflation ahead of Thursday’s decision (data due Thursday morning). We expect it to show core services momentum continues to fade strongly (though largely on seasonal factors). This, however, may do little to ease existing concerns over domestic/services inflation given labour market tightness. Ongoing geopolitical tensions also leave upside risks to the recent energy-driven disinflation. Overall, we expect cautious wording on inflation and a reiteration of expectations for a sustainable return to target in Q4 2025.
Economic Weakness Mounting
That below-target inflation has come with increased signs of economic weakness supports the case for a cut on Thursday. Minutes from the 12 September meeting already pointed to concerns over economic weakness; the macro backdrop has since worsened.
Earlier labour market strength is beginning to weaken. Evidence includes dismal manufacturing PMIs in Germany (the 40.6 is the worst globally after Myanmar), softening employment components of the euro-area PMIs, and announcements by major companies of planned or actual redundancies. Meanwhile, employment growth is slowing, albeit at a rate still-above ECB forecasts, while labour hoarding has declined.
By cutting again on Thursday, the ECB can address concerns over the labour market and growth outlook amid favourable inflation dynamics.
A Cautious Cut
By acknowledging the macro weakness and cutting again now, the ECB may gain more confidence it can stick to its gradual easing approach. But it is too early to conclude downgrades to growth and inflation forecasts in December. And as such, we expect a cautious cut with limited guidance on the future pace of easing.
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(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.)