FRANKFURT, Sept 12 (Askume) – The European Central Bank is almost certain to cut interest rates again on Thursday but investors will be closely watching its message for signs of further cuts as weak economic growth poses inflation risks.
The European Central Bank cut its deposit rate to 3.75% in June, and a group of policymakers are backing another cut, suggesting their debate at an upcoming meeting is likely to focus on how quickly borrowing costs should come down.
The likely outcome is that ECB President Christine Lagarde will stick to the bank’s recent statement that decisions will be taken on a meeting-by-meeting basis, based on the data received, without a prior commitment.
But she could also say all the meetings were “active,” leaving the door open for a rate cut in October, though some conservative hardliners are making a case for a slower rate cut while inflation pressures remain high across the 20-nation eurozone.
“Although a rate cut in October is likely … we do not think the information released between the September and October meetings will be weak enough to force a rate cut in October,” said Danske Bank’s Piet Hans Christiansen. The bank could.”
More dovish policymakers, mainly from the euro zone’s southern region, are likely to argue that the risk of recession is rising, with the ECB currently keeping interest rates higher than necessary as inflation approaches its 2.2% target, limiting economic growth.
But inflation-focused hawks remain in the majority, saying the labour market is too hot for the ECB to remain silent and that underlying price pressures, driven by stubborn service costs, are raising inflation risks.
New forecast
New economic forecasts are unlikely to resolve the debate.
The ECB staff’s quarterly forecast expects economic growth to decelerate slightly this year and inflation to remain at the same level as in June, returning to 2% on a “durable” basis in the second half of next year.
This means that some policymakers will resist further easing of policy rates, with the main differences being over how quickly the ECB should act.
“While we don’t think the ECB is in a hurry to cut rates, it also doesn’t want to keep rates too high for too long,” said Pimco portfolio manager Konstantin Veit, who expects a third rate cut in December and a further one at the staff forecast meeting.
Hawkish policymakers have made clear they believe quarterly rate cuts are appropriate because key growth and wages indicators – which inform the ECB’s own forecasts – are compiled every three months.
Investors are also divided, with financial markets seeing the prospect of another rate cut in December, but the probability of interim action in October hovering between 40% and 50%.
Lagarde’s main task at the 1245 GMT press conference will be to lay out all her options for October without raising expectations.
“For the time being, we believe rate cuts will continue on a quarterly basis as domestic inflation and underlying labour cost pressures remain quite elevated,” said Anatoly Annenkov of Societe Generale.
“We believe there must be signs of a sharp deterioration, particularly in the labor market, to accelerate policy, but this is not yet evident.”
Technical interest rate cut
Thursday’s measures will cut the ECB’s deposit rate by 25 basis points to 3.5%. At the same time, long-term technical adjustments could result in a significant drop in refinancing rates by 60 basis points.
The difference between the two interest rates has remained at 50 basis points for years, and the European Central Bank announced in March that it planned to narrow the gap to 15 basis points starting in September, which would ultimately ease the lending process between banks.
This recovery will take many years, so the ECB’s move is a pre-emptive adjustment to its operating framework.
Currently, banks hold 3 trillion euros of excess liquidity and deposit it overnight, effectively making deposit rates the ECB’s main policy tool.
This liquidity will diminish over time, forcing banks to borrow again from the ECB at the refinancing rate (traditionally the central bank’s base rate).
Once this happens, key rates will regain their dominant position, and a narrower interest rate corridor will help the ECB better manage market rates.
