ECB rate decision: what to expect on 17 October

Villeroy de Galhau told Italian newspaper La Repubblica that the ECB is likely to cut interest rates in October.

Rate reductions in October and December likely

“With 90% of economists predicting a 25 basis point cut in European Central Bank deposit rates next week, this decision seems almost on point. This will be the third rate cut of 25 basis points since June, the slow and methodical climb. -the rate cut that the ECB had hoped to achieve,” says Michael Field, European market strategist at Morningstar.

A further rate cut in December is also considered a done deal among experts, with money markets currently pricing in 25 basis point cuts for October and December.

“European inflation fell to 1.8% in September, the lowest level in three years, and below the central bank’s 2% target. While core inflation remains higher than this, the trajectory of the number has clearly been downward, a positive Unemployment in Europe is at record levels, but high by international standards, at almost 6%,” adds Field.

Eurozone inflation could rise again in Q4

“As with any monetary easing program, there are risks, but at this stage the risk of the economy overheating from further interest rate cuts appears low. Of course, the ECB wants to be careful and allow interest rates to find the right level, but the direction to go from here is clear,” says Field. Economists expect ECB rates to drop to 2.5% over the next 12 months.

Konstantin Veit, a portfolio manager at Pimco, points out in an interview with Morningstar that the central bankers’ latest comments are in contrast to the September meeting, where Lagarde hinted that data available before December would probably not be enough to to justify a rate change. September’s preliminary reading of 1.8% inflation was in line with market expectations and not far from the ECB’s own forecast.

Inflation is also expected to pick up again in the fourth quarter as earlier sharp declines in energy prices fade from annual rates and services inflation remained elevated at 4%. Economic data for the Eurozone has been disappointing recently.

“I think the ECB wants to reduce the key interest rate to 3% as quickly as possible from a risk management perspective, and this level is still restrictive,” says Veit.

Could the ECB keep rates steady in October?

ING’s Carsten Brzeski also points to the ECB’s wording at the September meeting, where the preference for the next rate cut in December seemed clear. Although Brzeski also expects a rate cut on October 17, he does not completely rule out a surprise. After all, no “hard” economic data has been released since the last meeting.

“We are far less certain than the financial markets that the ECB will actually cut rates next week. The main question for the ECB will be how it interprets the distinction between data reliance and data point reliance. If all the recent data is considered as one data point, there is no reason to cut at the October meeting If it is considered a large series of disinflationary data, Brzeski wrote in an Oct. 6 blog post.

“In any case, if the ECB decides to cut interest rates next week, it would mark an important shift in its own reaction function.”

How low will the ECB cut rates?

Deutsche Bank economists have also adjusted their expectations and now expect faster rate cuts than they did in the summer.

“Instead of policy rates returning to neutral (2.00-2.50%) by late 2025, we now expect neutral rates to be reached six months earlier in mid-2025,” they wrote in a research note titled “No Reason to Wait.” on October 1. This would mean a further 0.25 percentage point interest rate cut at each of the four meetings in the first half of 2025.

Bastian Freitag, head of fixed income Germany at Rothschild, also expects rapid rate cuts. “The decline in headline inflation is not just due to lower energy prices, but also a slowdown in core inflation,” says Freitag.

“For 2025, we now expect faster interest rate cuts, possibly at each ECB meeting, until the interest rate neutral level (2.0-2.5%) is reached.”

The ECB began its rate-cutting cycle in June, but paused in July. At the last meeting in September, the board then cut the deposit facility rate by 0.25 percentage points to 3.5%. As of September 18, the three key ECB interest rates were as follows:

• Deposit facility rate: 3.50%, down from 3.75%

• Prime refinancing rate: 3.65%, down from 4.25%

• Marginal Lending Facility Rate: 3.9%, down from 4.50%

Other major European central banks have also initiated interest rate cut cycles, most notably the Swiss National Bank, which was the first of the major Western central banks to accelerate interest rate cuts in March. Further interest rate cuts followed in June and September.

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.