ECB – a risky rate cut

At the last press conference in mid-September, ECB President Christine Lagarde gave the impression that the ECB would cut interest rates only in December, when it publishes its new economic forecasts. However, the Purchasing Managers' Index, an important leading indicator for the eurozone economy, has recently disappointed. In addition, inflation in September was lower than expected. Christine Lagarde reacted surprisingly clearly to this in a speech at the end of September and held out the prospect of a rate cut already at the October meeting. This is exactly what the ECB delivered today; the deposit rate fell by 25 basis points to 3.25%. Also as expected, the ECB justified the move with the recently weaker data. As a result, the disinflationary process "is well on track". Obviously, the ECB has become somewhat more certain that inflation will return to its 2% target in the medium term.

Rate cuts at every meeting from now on?

Due to this more optimistic view, the question of whether the ECB will continue to cut interest rates at every meeting and not just once a quarter came to the fore during the press conference. But Lagarde repeated her usual statement that the ECB does not pre-commit and decides meeting-by-meeting based on the data. Lagarde denied that she had already opened the door to a further rate cut in December.

Rate cut in December highly likely

However, the emphasis on the alleged data dependency of the ECB's interest rate decisions should not be overstated. The ECB is likely to cut interest rates further if the data roughly point in the intended direction. The recent decline in leading economic indicators is likely to result anyway in weak hard economic data. The fall in energy prices is also likely to have a knock-on effect on core inflation (excluding energy and food) for another month or two, lowering it indirectly – via e.g. transportation services. In this respect, a further interest rate cut in December is highly likely.

The ECB is likely to cut interest rates further after the turn of the year. However, in order for it not to loosen its monetary policy at every meeting, the leading indicators would have to recover and the phase of energy-related low increases in core consumer prices would have to end. The latter is supported by wages, which are still rising much faster than is compatible with the ECB's inflation target. This strong cost push should increase underlying inflation again in the medium term. In this respect, today's rate cut only five weeks after the last rate hike is risky.

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