Following the global inflation crisis that was largely overcome in the post-pandemic period, the second half of 2024 has witnessed major central banks beginning to ease their monetary policies. After the recent rate cuts by the central banks of Canada and the UK, attention is now focused on the European Central Bank (ECB) for a second rate cut this year.
Eurozone inflation had surged to an all-time high of 10.6% in October 2022, prompting the ECB to raise its policy rate to 4.5%, the highest level since the beginning of the century. Since then, price pressures in the region have eased, with inflation falling to 2.2% in August, the lowest level since July 2021.
In response to the decline in inflation, the ECB made its first 25-basis-point rate cut in June, but interest rates remain in a highly restrictive zone, which continues to exert pressure on Eurozone economies.
Growth data published last week revealed that the regional economy grew by only 0.2% in the second quarter compared to the previous quarter, falling short of earlier estimates. Annual growth stood at 0.6%, significantly behind the ECB's 2024 year-end growth forecast of 0.9%.
While manufacturing activity in the region remains in contraction territory, household consumption remains subdued, and economic sentiment is still below pre-pandemic levels.
ECB Policymakers Split: Inflation Battle vs. Economic Growth Concerns
Following the June meeting, President Christine Lagarde signaled that the fight against inflation was over, emphasizing that inflation risks remained a top priority. Since then, hawkish policymakers such as Joachim Nagel and Isabel Schnabel have warned about persistent inflation risks, while others have highlighted the need for the ECB to avoid excessively tightening the economy.
Executive Board Member Piero Cipollone warned last week that the ECB’s policy stance could become overly restrictive. Cipollone emphasized that the Eurozone urgently needs investment and growth and that any delay in policy adjustments could result in a significant disadvantage.
Markets Anticipate a 25 Basis Point Rate Cut
All 68 economists surveyed by Bloomberg predict that the ECB will make a 25-basis-point rate cut today. The ECB's deposit facility rate (DFR) currently stands at 3.75%. The main refinancing operations (MRO) rate, which allows banks to borrow from the ECB for one week or three months, is 4.25%, half a percentage point higher than the deposit rate. The marginal lending facility (MLF) rate, which allows banks to borrow from the ECB overnight, is at 4.5%.
However, the ECB announced last March that the difference between the DFR and the MRO would change as of September 18. The current 50-basis-point gap will be reduced to 15 basis points. Therefore, if the ECB implements the expected 25-basis-point rate cut, the rates for the DFR, MRO, and MLF will drop to 3.5%, 3.65%, and 3.9%, respectively.
The ECB manages its monetary policy through the DFR. Therefore, the narrowing of the gap between the DFR and MRO cannot be considered an additional policy easing; it is merely a technical adjustment. With this change, the ECB aims to incentivise commercial banks and reduce market volatility.
ECB’s Next Moves in Spotlight
The market has already fully priced in a 25 basis point cut in the deposit rate. Therefore, the key focus of this meeting for the markets will be the outlook the ECB presents for its future rate path.
Most market participants expect the ECB to cut rates quarterly until it reaches 2.5%. Consequently, the next cut, which is almost certain, is expected at the December meeting. However, following the latest economic data, bets on an additional rate cut in October have risen to around 37%. Meanwhile, ECB policymaker Gediminas Å imkus recently stated that expectations for additional easing in October are unlikely and inconsistent with the data.
In conclusion, the markets will look to President Lagarde's post-decision speech to clarify the ECB's policy trajectory. However, Lagarde will likely reiterate that upcoming decisions remain data-dependent, reminding that inflation has not yet been fully defeated.