- 25bps rate cut nailed on by money markets
- Updated staff projections forecast mostly unchanged
- Lagarde expected to be non-committal and data dependent
The European Central Bank is expected to deliver the second rate cut of this cycle on Thursday along with changes to its operational framework that were announced in March. As a result, the deposit facility rate will be cut by 25bps from 3.75% to 3.50%. The key question is what happens next into the end of the year, with two more meetings scheduled. Currently, markets give a 40% chance of another 25bps move in October, with this more than fully priced for December. Rates are seen around 2 to 2.25% by the middle of next year.
ECB officials have mostly indicated confidence in a September cut but the path and pace of more policy easing after this remains uncertain. Fresh quarterly staff economic projections are expected to be largely untouched. Attention will be on the inflation forecasts with possibly a small downward revision to the 2025 and 2026 estimates. That means markets may especially focus on wages and productivity which feed into next year’s inflation figure.
Recent quarterly growth projections by the ECB have been too optimistic with GDP last time expected at 1.4% next year and 1.6% in 2026. Certainly, any major downward revisions to growth or inflation would increase the likelihood of a more rapid pace of rate cuts, while upward revisions would motivate the hawks to slow down further rate cuts.
Recent data
Data over the past few weeks have overall supported the case for further rate cuts from the ECB. Excluding the one-off boost from the Olympics, soft indicators have weakened over the summer, while the labour market is showing signs of moderation as seen in the stagnation of the PMI employment measure and decline in negotiated wage growth.
Inflation expectations have fallen and recently stabilised, and core inflation has dropped to 2.8% y/y. Still, August’s core inflation at the margin was among the hottest months of August on record which is used because the data is not seasonally adjusted, and services inflation remains sticky.  This will concern the hawks on the Governing Council. The headline figure recently hit a three-year low at 2.2% y/y, but this was primarily due to base effects on energy prices.
Market reaction
Fading inflationary pressures are the chief argument in favour of another rate cut. But a low unemployment rate means wage growth is probably still too high to signal more policy easing at this stage. That means the ECB is expected to be relatively cautious with little or no forward guidance, with decisions made meeting-by-meeting. There are around 60bps of rate cuts priced in for this year.
Focus will be on any policy hints at all from President Lagarde. If nothing is forthcoming, then EUR/USD reaction may be limited. However, the dollar side of the major will move on next week’s FOMC meeting, with incoming Fed rate cuts and positive risk sentiment potentially keeping the pressure on any major dollar rallies.