ECB cuts rates as expected and cuts growth outlook

“After the first cut in June, the ECB wisely gave it a few months to sit back and monitor the effects. Their vision is clear, it is better to move slowly and steadily in one direction than to move too fast and have to change. course by course,” Morningstar strategist Michael Field commented, adding that June’s economic data validated this course of action.

“Inflation picked up, but eventually eased to a level very close to the central bank’s target, while economic growth remained positive but benign,” Field added.

The differences between rates must be reduced

As announced by the ECB in March this year, the main refinancing operations (MRO) rate will be adjusted so that the spread between the MRO and deposit facility rates is reduced to 15 basis points from the current spread of 50 basis points . points.

ECB President Christine Lagarde declined to elaborate on the bank’s future rate-cutting trajectory, echoing earlier statements that the ECB’s governing council would take a data-driven, meeting-by-meeting approach.

From 18 September, the three key ECB interest rates will remain at:

• Prime refinancing rate: 3.65%, down 0.60 percentage points from 4.25%

• Marginal lending facility interest rate: 3.90%, down 0.60 percentage points from 4.50%

• Deposit facility rate: 3.50%, instead of 3.75%

Currently, the most important rate is the interest rate on the deposit facility, which defines the interest that banks receive for depositing money with the central bank overnight. It is also the most important interest rate for economists because it has a direct impact on savings or checking accounts that accrue interest.

European stocks were largely unchanged, as expected. The euro initially strengthened against the dollar.

This is the second interest rate cut on the deposit facility in five years, following the initial cut in June, while the other two rates were last cut in 2015. It follows 10 rate hikes since the Frankfurt-based institution began its rate hike cycle in July 2022. .

Eighty-five percent of economists polled by Reuters expected a rate cut, and the vast majority are now looking for a third rate cut of 0.25 percentage points this year in December.

Meanwhile, markets priced in nearly four cuts in 2024 earlier this week, assigning some likelihood to a further step in October.

ECB cuts growth outlook, slightly raises core inflation outlook

According to the latest Eurosystem staff forecasts, headline inflation will average 2.5% in 2024, 2.2% in 2025 and 1.9% in 2026, as in the June projections. “Inflation is expected to pick up again in the latter part of this year, in part because previous steep declines in energy prices will fade from annual rates. Inflation should then decline towards our target in the second half of next year.”

“For core inflation, projections for 2024 and 2025 have been revised up slightly as services inflation has been higher than expected. At the same time, the staff continues to expect core inflation to decline rapidly, from 2.9% this year to 2.3% in 2025 and 2.0% in 2026,” the statement added.

The ECB previously estimated core inflation for 2024 and 2025 at 2.8% and 2.2% respectively.

“Domestic inflation remains high as wages continue to grow at a high pace. However, labor cost pressures are moderating and profits are partially cushioning the impact of wage increases on inflation. Financing conditions remain tight and economic activity is still reduced, reflecting weak private consumption and investment.

The staff expects the economy to grow 0.8% in 2024, reaching 1.3% in 2025 and 1.5% in 2026. This is a slight downward revision compared to June’s forecast of 0.9%, 1 .4% and 1.6%, mainly due to a weakening. the contribution of domestic demand over the next few quarters.

The Fed is expected to cut rates next week

The ECB acted ahead of its US counterpart, which is expected to initiate interest rate cuts at its next meeting on September 17 and 18. “With inflation normalizing, there is little reason to keep rates at extremely restrictive levels, which risks triggering a recession.” say Preston Caldwellchief US economist at Morningstar.

Swiss National Bank was the first major bank to announce a rate cut in March, followed by Sweden’s Riskbank in May. On the other hand, the Bank of England was the last major European central bank to cut interest rates when it announced it would cut rates to 5% on August 1. Another BoE rate cut on September 20 would surprise markets.

How much will European interest rates fall?

Morningstar’s Field says “the risk of the economy overheating from further rate cuts appears low, suggesting that economists’ expectations of one more rate cut before the end of the year are very likely. The ECB model of reducing, monitoring and repeating is likely. to continue”.

Most analysts expect the ECB to continue its downgrade cycle in 2025, with three or more cuts of 0.25 percentage points by September 2025. Fidelity expects three more quarterly cuts in 2025, lowering the interest rate to a target of 2.50% in September 2025, Fidelity’s Carsten Roemheld said last week.

Analysts at DWS agree. In 2025, rates will fall by 25 percentage points each quarter until the target interest rate of 2.50% is reached in September 2025, predicts Ulrike Kastens, European economist at DWS. “The ECB’s Governing Council will certainly want to avoid cutting interest rates too quickly and thereby accepting a renewed rise in inflation,” she told Morningstar in a Sept. 5 interview.

Bastian Freitag, head of fixed income in Germany at Rothschild & Co, said he also expects cuts of 25 basis points each in September and December, as well as other quarterly milestones in 2025. While inflation is likely to rising slightly at the end due to base effects, the rate is gradually moving towards 2%, he said. Risks are driven by service price inflation, the price of oil, a slight pick-up in money supply growth and wage trends, Freitag told Morningstar on Sept. 5.

How will interest rate cuts affect the markets?

Equity markets tend to rise based on anticipated interest rate cuts. In bond markets, falling interest rates mean lower yields, which pushes bond prices higher. Lower rates also make existing bonds, and especially those already issued in a period of high rates, more attractive for yields.

Meanwhile, cash savings rates on bank accounts are likely to fall, to the detriment of savings. The rates that savers receive depend mainly on the deposit facility, which defines the interest that banks receive for depositing money with the ECB overnight.

Borrowers, on the other hand, will benefit from lower rates as consumer debt and mortgages become cheaper.