ECB could lower rates for a second time in a row as the euro zone economy struggles

The European Central Bank (ECB) is poised to lower interest rates for the third time this year on Thursday, citing improved control over euro zone inflation and a stagnating economy. This move, marking the first consecutive rate cuts in 13 years, signals a shift in the ECB’s focus from reducing inflation to safeguarding economic growth, which has lagged behind the U.S. for two consecutive years.

Recent economic data likely tipped the balance in favor of a rate cut. Business activity, sentiment surveys, and September's inflation figures all fell slightly short of expectations. In response, several ECB officials, including President Christine Lagarde, have indicated that a reduction in borrowing costs is imminent, prompting investors to fully anticipate the cut.

"Given the slowdown in growth and the easing of inflation, we now expect the ECB to cut rates by 25 basis points at each of the next four meetings," said UBS economist Reinhard Cluse.

A quarter-point cut on Thursday would bring the ECB’s deposit rate to 3.25%. Money markets also anticipate three additional cuts by March. Lagarde and her colleagues are likely to refrain from offering explicit guidance about future actions, maintaining their position that decisions will be made "meeting by meeting" based on incoming data. Nevertheless, many analysts expect rate cuts to continue until the spring.

"We anticipate a 25 basis point cut at the October 17 meeting, with further cuts of the same size at each meeting through March," said Antonio Villarroya from Santander CIB. "However, by mid-2024, rates could still be above neutral, so a final 25 basis point cut might come in June."

A neutral interest rate is considered the level where monetary policy neither stimulates nor slows the economy, which is estimated to be between 2% and 2.25%.

Inflation and Growth Outlook

The ECB can now assert that it has largely curbed the worst inflation spike in over a generation. Prices rose just 1.8% last month, dipping below the bank’s 2% target for the first time in three years. Although inflation could briefly exceed 2% by the year’s end, it is expected to hover around that mark or slightly lower in the medium term, the timeframe closely watched by policymakers.

However, the economy has paid a steep price. High interest rates have hampered investment and stifled economic growth, which has been weak for nearly two years. Recent data, including industrial production and bank lending figures, suggest more sluggishness in the coming months.

Even the resilient labor market is beginning to show signs of strain, as the vacancy rate—representing job vacancies as a proportion of total jobs—has begun to fall from record highs. This trend has intensified calls within the ECB to ease monetary policy before further damage is done.

"We now face a new risk: inflation falling short of the target, which could suppress economic growth," said Portuguese central banker Mario Centeno. "Fewer jobs and reduced investment would compound the economic sacrifices already made."

Some of this economic weakness stems from structural issues, such as high energy costs and declining competitiveness, particularly affecting Germany, Europe’s industrial hub. While lower interest rates cannot fully address these problems, they can provide some relief by making borrowing more affordable.

"We must acknowledge the headwinds facing growth," said ECB board member Isabel Schnabel. "At the same time, monetary policy alone cannot solve structural challenges."

 

 

 

 

 

 

 

Paraphrasing text from "Reuters" all rights reserved by the original author.