In just a few days, the European Central Bank’s (ECB) interest rate cut for October went from a distant possibility to being fully priced in by the market. Operators give it a probability of more than 90% and the story has changed considerably. However, analysts are emerging who warn that the decline is not as assured as is believed in the stock markets. This would not be the first time that the ECB has said I say where Diego said. In recent days, doubts began to arise about the ECB’s next decision when everyone was already convinced that the rate cut was “deal done‘(deal done). The sharp rise in the price of oil, in an almost meteoric movement, could coincide over time with a temporary rebound in inflation (the base effect disappearing). The “hawks”, who seemed completely disarmed a few days ago, could now gather their forces to wage “war” on the “doves”, in what will be an interesting debate. The October meeting will give more play than it seemed a few days ago after the speech by Christine Lagarde, President of the ECB.
Everything seemed ready for a rate cut
Although, after the September meeting, its officials made it clear that in October there should be a break to analyze the data and continue the declines of December, everything conspired in favor of a further decline. First, the “giant” rate cut by the US Federal Reserve, which lowered them by 50 basis points (double the norm) in one fell swoop.
Then, some weak activity indicators in the euro zone. And finally, inflation in September below the 2% target in the four major economies of the euro zone, a decline favored by a sharp drop in oil prices. The words of the bank’s president, Christine Lagarde, opening the door to the reduction last week after having excluded it and the statements of Isabel Schnabel, a prominent hawk of the organization, leader of this sector during the cycle of rise, showing its concern over growth supported the market’s momentum.
François Villeroy de Galhaua member of the Governing Council, also indicated that the ECB would “very likely” cut interest rates at its next meeting at the end of this month. Inflation fell below the ECB’s 2% target in September and the underlying measure of price growth is expected to gradually fall near this level in 2025 (although this has not happened yet) , declared the head of the Bank of France in an interview with La Repubblica.
He also said that market expectations for inflation in 2025 were below 1.8%, even lower than the ECB forecast. “All this means is that the balance of risks changes“, he said. “Over the last two years, our main risk was exceeding our target of 2%. “We must now also pay attention to the opposite risk, that of missing our objective due to weak growth and restrictive monetary policy for too long.”
Why these last minute doubts?
However, it is analysts like those at ING who warn that the reduction is not as clear as the market believes. “So far, no solid macroeconomic data has been released since the September ECB meeting. The fear of a further weakening of economic dynamics is due exclusively to sentiment indicators. The same sentiment indicators as the ECB assessments recently are often not entirely reliable. In addition, the loss of a certain economic dynamic is already integrated into the projections of the ECB services,” writes Carsten Brzeski, economist at the “orange bank”. , in a note to customers.
This expert insists and assures the following: “We believe the decision to cut rates will be much more controversial than markets currently think.”…Recall that at the press conference of the ECB’s September meeting and in the two weeks following that meeting, the official message from the ECB was clear: the ECB was very comfortable with a pace very gradual reduction in interest rates. a tightening of monetary policy, that is to say a gradual and measured pace of rate reduction. October meeting would come too soon for the ECB to see fundamental changes in their own assessment of growth and inflation”, they emphasize from the Orange Bank.
Furthermore, the sharp rise in the price of oil in just over seven sessions could bring back the ghosts of inflation. Experts and the ECB itself already expected a slight acceleration in the CPI in the latter part of the year, but they probably did not count on oil which rose by 10 dollars in a week and which threatens to continue to increase because of the conflict. between Iran and Israel is “heating up”. This is a problem because the ECB has used inflation as an “excuse” to accelerate rate cuts to 3.5% (the deposit rate).
“As for inflation, Lagarde had already telegraphed the fall in general inflation at the September meeting. And, indeed, with general inflation at 1.8% year-on-year in September, this was exactly in line with the Lagarde’s own forecasts. “For the future, overall inflation continues to depend largely on the evolution of oil prices. Although September’s fall in oil prices was a significant factor in lowering overall inflation, ongoing tensions in the East have pushed prices up again. “Available national data suggests that services inflation remains high. This is an additional argument for the ECB not to cut rates next week,” Brzeski continues.
The market anticipates a cut by the ECB
Despite everything, expectations continue to show that the market expect a discount with 90% probability: “However, this central bank model which must follow market expectations plays a more important role in a cycle of increases than in a cycle of easing”, they say from ING. In a rate hike cycle, proposing increases lower than what markets are pricing in may mean that inflation and growth will end up being higher (expectations are not anchored) than in the base case.
“However, in an easing cycle, offering fewer interest rate cuts than markets are pricing in actually means lower inflation (and lower growth). In a situation where it is far from certain that inflation is once again maintained at the target level, this is a solution with which the ECB could live more easily”, they emphasize from the Orange Bank.
Overall, the December meeting was clearly the preferred option for the next rate cut, as it would a meeting with updated macroeconomic projections. In short, after the September meeting, the stage was set for a quarterly rate cut. Are this series of weak confidence indicators and the decline in headline inflation really reason enough to review the September strategy? ING experts are asking themselves the question.
Perhaps the most effective option would be to continue the rate cut in October (it has already been announced to the market and to do otherwise would call into question the credibility of the central bank) and leave December on hold. , when the ECB already has its new “macro” forecast table. However, the “hawks” know that every rate cut is a losing battle that can no longer be won, which is why a very close meeting is expected.
The economy is not new
On the other hand, the deterioration of growth prospects cannot be explained solely by recent data. In fact, confidence indicators had already been falling since June and all weak indicators point to weaker growth in the third quarter than in the second. In its September projections, the ECB already predicted that euro zone GDP growth would fall to 0.2% quarter on quarter in the third quarter.compared to 0.3% quarterly in the second quarter, but the risks are now clearly oriented to the downside. Finally, the latest round of disinflationary data has allowed ECB supporters to move higher, with several ECB officials explicitly opening the door to a rate cut in October.
So far, no concrete macroeconomic data has been released since the ECB’s September meeting. The fear of a further weakening of economic dynamics is due exclusively to sentiment indicatorsthe same sentiment indicators that the ECB described not so long ago as unreliable. In addition, the loss of a certain economic dynamic is already integrated into the ECB staff’s projections. Markets were reassured that ECB member Isabel Schnabel said in a recent speech that “we cannot ignore the obstacles to growth”. However, in the same speech, Schnabel also highlighted the fact that monetary policy could do little to address structural weaknesses.
Oil drives up energy prices
At Oxford Economics, its analyst Ricardo Amaro is of the same opinion. “We consider it quite extreme that the financial markets are pricing in almost 100% of the probability that the ECB will cut its rates in October”he blurted out in his last comment. Amaro urges not to interpret the latest Eurozone CPI data as proof that the war against inflation has been won.
On the one hand, he warns, the fall below 2% could prove short-lived, since base effects are less favorable from a disinflation perspective in the fourth quarter. Furthermore, he adds, the slowdown in service dynamics in September was unusually rapid. As an example, he illustrates, the dynamics of inflation in services slowed down sharply in November last year, but ultimately it didn’t last long. On the other hand, adds Amaron, energy prices are once again more uncertain.
“When oil prices were lower than expected, that was one thing, but with tensions escalating in the Middle East, risks in that area are reignited,” he writes. Again, Amaro believes that this time it will be the pigeons who will take the prize: “The hawks in the Governing Council will probably cling to the need not to depend on data, in line with President Lagarde’s assessment during the September monetary policy meeting. Furthermore, they might view the growth in core and services inflation as too slow, given that both measures fell by only 0.1 percentage points in September in rounded terms. But taken together, we think the latest polls and inflation data have provided enough ammunition for the pigeons to win their case.”
