Analysis-Big Fed tapering puts ECB move next month on traders’ radar By Reuters

By Balazs Koranyi and Francesco Canepa

FRANKFURT (Reuters) – A significant interest rate cut by the U.S. Federal Reserve raised bets on continued European Central Bank policy easing in October on Wednesday, but that is not yet the most likely outcome given the different economic realities.

The ECB already cut interest rates in June and earlier this month, and many at the bank have suggested steady quarterly rate cuts to ensure inflation is tackled on a sustainable basis.

While the Fed’s apparent haste supports arguments that the ECB is behind the curve given the rising recession risks, the underlying economics did not change overnight, so policy hawks in the Governing Council may argue to wait until December.

“That the ECB has to cut in October because of what the Fed has done is a ridiculous argument that would not fly in the Governing Council,” said Dirk Schumacher, an economist at Natixis.

“The only way to argue this is to say it (Fed tapering) is going to change the data in the euro area, and that might be the case, but we haven’t seen it yet.”

This is also reflected in market prices, which now see a 35% chance of a 25 basis point deposit rate cut in October, up from 30% a day ago, a small change but still notable, which leaves December as the most likely date for an ECB move.

The ECB is likely to take it more slowly as it has much less to do.

It has five, maybe six cuts of 25 basis points until it reaches a “neutral” interest rate level of around 2.0% or 2.25%, according to various estimates that include the ECB.

Meanwhile, the Fed is likely to have eight such cuts by then, so the world’s top two central banks could still reach their endpoint of policy easing at the same time.

Then there are the fundamentals.

Eurozone inflation, now at 2.2%, could rise to 2.5% by the end of the year and is likely to fall only slowly to 2% in the final weeks of 2025 as entrenched wage pressures push up service costs.

That’s why conservative policymakers, or hawks in market jargon, have warned against moving too quickly.

Slovakia’s Peter Kazimir already pulled out in October, while rate-setters Isabel Schnabel and Klaas Knot have both backed arguments in the past that quarterly moves to coincide with new projections made sense.

“Inflation is currently not where we want it to be,” Bundesbank chief Joachim Nagel said on Wednesday.

The Conservatives, who have led a record string of rate hikes in 2022 and 2023, are likely to still be in the majority and that is why markets are not pricing in ECB moves after the Fed’s decision.

“Ultimately, louder hawks should keep markets reluctant to price in more ECB easing despite the Fed’s accommodative influence,” said ING’s Francesco Pesole.

The Hawks argue that wage growth remains too fast for comfort.

Labor costs rose 4.7% in the second quarter, well above the 3% seen in line with the ECB’s inflation target, and unions continue to demand big pay rises to offset real income losses.

Also, the ECB receives only a few truly relevant data in the four weeks leading up to its October 17 meeting.

Figures on wages and growth come only before December, when new projections are also released. This leaves the ECB with second-tier figures such as survey data on lending and corporate intentions.

These weaker indicators would then need to show a large deterioration for policymakers to anticipate their own rate cut projections.

THE PORBULE

However, policy doves, mostly in southern Europe, continue to support faster policy easing.

Mario Centeno, head of Portugal’s central bank and the most outspoken political dove, says the growth outlook is deteriorating so quickly that the ECB could overshoot its inflation target if it does not move quickly.

“Given where we are today in the monetary policy cycle, we need to minimize the risk of overshoot because that’s the main risk,” Centeno told Politico.

Doves argue that growth is faltering, industry is in recession, consumption is weak and people are increasing their savings, perhaps out of fear of an economic downturn.

These factors are all deflationary and create downside risks to rising prices.

They also say that inflation will fall to target in September, and even if there will be an increase in the coming months, the specter of rampant inflation has been defeated, especially as energy prices remain subdued.