The European Central Bank (ECB) is now ready to lower interest rates again, after the first move it made in June. The members of the organization’s Governing Council have admitted that the reduction will take place next week and no surprises are expected in this regard. The novelty of this meeting is that the ECB will update its macroeconomic forecast table, and analysts expect only a downward revision of GDP growth estimates for the year 2024. The economic progress forecast for 2025 and 2026 will remain the same, and there will be no change in the inflation forecast table either. If this is true, it opens up a scenario in which the ECB will be able to lower rates without fear of triggering the CPI again, but Analysts expect a quiet cycle, with the ECB alternating a rate cut every two meetings.
The rate cut that the ECB will make in September is not new. Up to eight members of the entity’s Governing Council have been responsible in recent weeks for publicly confirming that the organization will reduce the price of money at next Thursday’s meeting, and it is a move that has been completely ignored by the markets for months. With this decision already taken by analysts and investors, it is important to have a panoramic vision to try to analyze what the cycle of cuts will look like in the medium and long term.
It is on the longer terms that the differences between analysts and investors are evident. The market has priced in a relatively aggressive rate cut process and expects the ECB to make between 6 and 7 rate cuts of 25 basis points over the next 12 months. The estimate has fluctuated in recent days between 150 and 175 basis points of cut over this period, but Analysts warn of a calmer scenario of central bank tapering.
In the latest survey of analysts BloombergExperts are talking about a much less aggressive rate process: they are predicting rate cuts of 125 basis points by September 2025, and they believe that the ECB will complete this process by lowering rates at every other meeting. If the expected scenario comes to fruition, the cuts would come at the September, December, March, June and September meetings, at which point the price of money will reach its terminal rate in this cycle, with the reference rate (the deposit facility) at 2.5%. Thus, the process of reductions started last June will end in September 2025.
This scenario corresponds to the ECB’s macroeconomic forecasts, which, according to the analysts surveyed, will envisage a deterioration in the economy, but which will not be accompanied by a fall in inflation compared to current estimates. Thus, GDP growth is expected to deteriorate, but without being accompanied by a fall in inflation. In this way, the ECB would act cautiously, to try to support economic growth, but without going too far in reducing rates, to avoid a new inflationary surge. This would obviously be disastrous for an ECB that has lost credibility in the face of the price increases that occurred in 2021 and 2022, after denying for months that this was going to happen.
Dennis Shen, economist at Scope Ratings, points out that the macroeconomic deterioration in the eurozone “supports the case for more accommodative monetary policy, but inflation remains undefeated,” he recalls, which will prompt the ECB to remain cautious at all times in the coming quarters and avoid aggressive rate cuts during this cycle.
It is on this balance between inflation and growth that the Fed’s rate-cutting process will focus. Indeed, while the average of analysts surveyed does not expect a decline in CPI forecasts, either for 2024 or for the next two years, there are still many who see enough signs of inflation weakness that could lead the ECB to be more aggressive in the months ahead. David Meier, economist at Julius Baer, explains in his latest report how “the dynamics of lower inflation in Germany and the euro area as a whole seem to be driven by weak demand, which makes price increases increasingly difficult, and which have a negative impact on labor market dynamics,” he emphasizes. This is what leads the Swiss bank to add a further drop in the price of money by 2025, and already expects, as investors do, three rate cuts in the next three meetings. Everything will depend on whether inflation continues to show signs of weakness.
In this sense, the hawks of the Governing Council of the central bank will most likely warn at the meeting that inflationary dangers persist in the eurozone, unlike the doves, who will be more inclined to support the economy with a more lax monetary policy, even at the risk of relaunching inflation, or not reaching the 2% target that the ECB maintains soon. The debate will include for the first time the new president of the Bank of Spain, José Luis Escriva, who will make his debut at an ECB meeting as a member with voting rights.
For the analysts interviewed, The ECB’s biggest concern for the coming months, due to the negative impact this could have on the eurozone economy, is the evolution of global geopolitical tensions. Behind them, the second biggest danger is the US elections, and third, “supply chain disruptions.” These three dangers are a reminder that the risk of a new rise in inflation is not negligible, since all three have the potential to be a source of further losses in currency value in the months to come.
