Five questions for the ECB By Reuters

By Yoruk Bahceli and Stefano Rebaudo

(Reuters) – The European Central Bank looks almost certain to cut interest rates again on Thursday, but the outlook beyond that is less clear.

Polite policymakers are conflicted about whether a weak growth forecast is enough to end inflation worries.

“This cut is relatively uncontroversial, so it’s more about messaging,” said Soeren Radde, head of European economic research at hedge fund Point72.

Here are five questions for markets:

1/ What will the ECB do on Thursday?

It almost certainly cut its deposit rate by 25 basis points, focusing investors on clues about what will happen next.

Since the ECB’s last meeting, traders have fully priced in another cut after September, most likely in December, and are betting there is a chance of a cut in October.

In mid-July, they saw less chance of a cut after September, so investors are keen to hear what, if anything, ECB chief Christine Lagarde has to say about a potential move in October.

ECB policymakers have yet to approve back-to-back cuts.

“Lagarde will not abandon the rhetorical position that the ECB will be heavily dependent on data,” said Felix Feather, economist at asset manager abrdn.

2/ Can the ECB stop worrying about inflation?

More than at any point in this cycle.

Inflation came closest to the ECB’s 2% target from 2021 in August at 2.2%. Wage growth is slowing.

The bloc’s recovery has been slow and Germany’s economy contracted in the second quarter, so doves signal the risk that too slow a cut could push inflation even below target.

However, disinflation has come from energy and goods and has likely run much of its course, economists say.

The ECB expects inflation to reach 2.5% at the end of the year.

Core inflation remains just below 3% and services inflation of over 4% has not eased this year, so hawks want to see a further decline to ensure inflation is under control.

“Inflation is proving to be quite persistent, the labor market is resilient and growing, it’s disappointingly weak but equally not negative,” Point72’s Radde said.

So the ECB has little to lose by cutting interest rates on a quarterly basis, he added.

3/ What will the new ECB projections show?

Growth was lower than the ECB expected in the second quarter and underlying inflation was sticky, so economists believe the bank will revise down growth and possibly slightly revise down its core inflation projection for this year.

That should not change the longer-term picture, where the ECB expects inflation to return to 2 percent at the end of 2025, economists said.

4/ What are the implications of a stronger euro?

Marginal.

The euro rose to $1.12015 in late August, the highest level in more than a year, and hit a record high on a trade-weighted basis.

A stronger currency, in theory, bodes well for taming inflation, but much sharper and longer-lasting moves would be needed to have a material impact, ECB research has shown.

5/ What will the renewed ECB rate system mean?

Not much, for now.

The ECB announced a new framework in March that sets out how it will provide liquidity as it drains billions of euros of cash from the financial system.

To support banks as cash needs rise, the ECB cut the premium it must pay to borrow at its weekly cash auctions relative to the interest the central bank pays on deposits to 15 bps from 50.

The change takes effect for the first time on Thursday, so a 25bps cut in the deposit rate will mean a 60bps cut in the main refinancing rate.

The change aims to balance money market stability by ensuring banks are not penalized for borrowing from the ECB, with the relaunch of interbank lending.

But currently the excess liquidity is around €3 trillion compared to less than €2 billion borrowed at the ECB’s last auction, so it will take years for the change to have an impact.

What may matter more are the details the ECB will eventually release about the long-term borrowing and bond-buying operations it will launch once its balance sheet grows again.

“Until they do that, we never know exactly how the money market will be structured,” said Frederik Ducrozet, head of macroeconomic research at Pictet Wealth Management.