ECB Watch: the direction is clear the pace is not
An interest rate cut of 25 basis points and a reduction in the key rate corridor are the highlights of today's ECB meeting. As expected, there were no clear signals on the pace of future rate cuts. The combination of prolonged economic weakness and persistent service price inflation does not present the ECB with an easy task. We take no signals from today's interest rate meeting to change our expectation of a rate cut in December - and none in October.
At today's interest rate meeting, the ECB Governing Council decided to reduce its key rates again. Following the interest rate cut in June, the deposit rate was reduced again by 25 basis points - to 3.50%. This was in line with our expectations as well as those of the majority of financial market participants.
In addition to the reduction in the deposit rate, the corridor between the main refinancing rate and the deposit rate was changed. Whereas this was previously 50 basis points, the main refinancing rate will only be 15 basis points above the deposit rate from September 18, 2024 onwards. The marginal lending rate, on the other hand, will remain 25 basis points above the main refinancing rate, as before. The ECB was keen to emphasize that this change will not affect the monetary policy stance, as this is determined by the deposit rate alone. We share this opinion in the short term, but in the medium term this change should have an impact on money market rates as soon as the ECB has sufficiently reduced excess liquidity.
None of this came as a surprise. Rather, the main focus was on the monetary policy outlook. Newly presented economic forecasts can provide an initial insight. The ECB's growth outlook has marginally worsened compared to June. GDP growth was lowered from 0.9% to 0.8% for 2024 due to weaker domestic demand (private consumption & investment). Leading indicators point to continued weakness, according to the ECB. In contrast to GDP, however, the core inflation forecast was raised - to 2.9% in 2024 and 2.3% in 2025. Persistent services inflation continues to be a problem and is reflected in this upward revision. The forecast for headline inflation, on the other hand, remained unchanged due to a lower contribution from energy prices.
The combination of weak economic momentum and persistent service price inflation is the ECB's Achilles heel. From President Lagarde's comments during the press conference, it can be concluded that a quarterly rate cutting cycle is most likely as long as the disinflation process is gradual (i.e. in line with forecasts). Given that Lagarde has already emphasized her expectation of a temporary decline in inflation in September, constant key rates at the next meeting in October seem likely. This is in line with our forecast, which assumes the next rate cut in December. Unfortunately, there were no more definitive signals on the future key rate path. Only the usual reference that the ECB acts data-dependently.
Interestingly, no questions were asked about any implications of the Fed possibly acting faster with respect to rate cuts and therefore no answers were given. Nothing was asked about the reduction of the key rate corridor either and its implications for money market interest rates. There was also no focus on balance sheet policies.
On financial markets the ECB meeting came with no major market reactions. The interest rate markets initially reacted with slightly falling rates, but these were reversed in the course of the press conference - when Lagarde mentioned that the neutral rate could possibly be somewhat higher than in the past. EUR/USD rose slightly, but the momentum is by no means unusual for a daily movement. All in all, the ECB meeting did not provide any directional signals to the financial market.
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Franz ZOBL
Austria Franz joined Raiffeisen Research's Economics, Rates, FX team in 2020 primarily focusing on US monetary policy, benchmark yields and EUR/USD. Prior to joining RBI, he worked as a research economist in the financial sector. He holds a PhD from the London School of Economics and studied at the Vienna University of Economics, the University of Vienna as well as Tilburg University. He is a published author within the field of macroeconomics and has a passion for economic history.
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