FRANKFURT, Sept 19 (Askume) – The Federal Reserve’s sharp interest rate cut on Wednesday has increased the likelihood that the European Central Bank will ease policy in October, but that is the most likely outcome given different economic realities.
The European Central Bank cut interest rates in June and earlier this month, and many at the bank have said successive quarterly cuts are needed to sustainably beat inflation.
While the Fed’s apparent haste provides some support for the argument that the ECB is lagging behind as recession risks rise, fundamental economic conditions do not change overnight, so policy advocates in the Governing Council may argue for waiting until December before taking action.
“The argument that the Fed will push the ECB to cut interest rates in October is a ridiculous argument that the Governing Council will not accept,” said Dirk Schumacher, economist at Natixis.
“The only way to argue this is that it (Fed rate cut) will change the euro zone data, which might happen but we haven’t seen it yet.”
This is also reflected in market pricing, which puts the probability of a 25 basis point cut in deposit rates in October at 35%, compared with 30% a day earlier. This is a small but still notable shift, making December the most likely date for ECB action.
The ECB is likely to delay moving on the issue as it has little work to do.
According to various estimates, including the ECB’s own, it will cut interest rates by between 25 basis points and 5 or 6 basis points until it reaches a “neutral” interest rate level of around 2.0% or 2.25%.
The Federal Reserve could make eight such rate cuts by then, so the world’s two biggest central banks could reach the end of policy easing at the same time.
Then there are the basics.
Eurozone inflation, currently at 2.2%, could rise to 2.5% by the end of this year and fall gradually to 2% by the end of 2025 as wage pressures push up service costs.
This is why conservative policy makers or market terminologists warn against moving too fast.
Slovakia’s Peter Casimir has postponed an October rate cut, while influential rate setters Isabel Schnabel and Klaas Nutt have argued in the past that quarterly moves fit the new forecast.
“At the moment, inflation is not where we want it to be,” Bundesbank President Joachim Nagel said on Wednesday.
Conservatives, who have called for record rate hikes in 2022 and 2023, are likely to remain in the majority, which is why markets did not re-evaluate the ECB’s move after the Fed’s decision.
“Finally, despite the Fed’s dovish stance, the market is still reluctant to see further easing due to the ECB’s hawkishness,” said Francesco Pesole of ING.
Hawks believe wage growth is still well above comfortable levels.
Labour costs rose 4.7% in the second quarter, well above the 3% assumed in the European Central Bank’s inflation target, and unions are demanding significant pay rises to compensate for real income losses.
The ECB will only receive some of the relevant data in the four weeks before its October 17 meeting.
Wages and growth data will be released only by December, when new estimates will also be released. This leaves the ECB with secondary data such as surveys of lending and business intentions.
Policymakers would need to see a sharp deterioration in these soft indicators before anticipating a rate cut.
Pigeon
Nevertheless, most policy experts in Southern Europe advocate rapid policy implementation.
Mario Centeno, president of the Bank of Portugal and its most outspoken policy expert, believes the growth outlook is deteriorating rapidly and that the inflation target will not be achieved if the ECB does not act quickly.
“Given the monetary policy cycle we are in right now, we really have to mitigate the downside risks because that is the main risk,” Centeno told Politico.
Dove believes that growth is slowing, industry is in a slump, consumption is weak and people are saving more, perhaps out of fear of a recession.
All these factors could lead to deflation and pose downside risks to price growth.
He also said that inflation will fall to the target in September and that even if inflation rises in the coming months, concerns about uncontrolled inflation will disappear, especially if energy prices remain stable.
