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 announcement as inflation risks remain despite a rebound in the euro zone economy.
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.
But she could also say all the meetings were “positive”, leaving the way open for a rate cut in October, despite some conservative “hawks” making the case for a slower pace of easing while inflation is still high across the 20-nation euro zone.
“All eyes will be on future news about rate cuts, especially the possibility of another 25 basis points reduction in early October,” economist Antonio Villarroya said.
More dovish policymakers, mainly from the euro zone’s southern region, are likely to say that with recession risks rising and inflation approaching its 2.2% target, the ECB may now be restrained from raising interest rates further.
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.
“The eagles haven’t taken flight yet,” says Davide Oneglia of TS Lombard. “Their new goal is to manage rate cut expectations… and be prepared for an increase in the Governing Council’s confrontation with policy rate cuts.”
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.
“We expect the ECB to take a similar stance as in June: making it clear that interest rates will continue to fall but giving no clear signal on the size and timing of the next move,” said Greg Fuzesi, an economist at JPMorgan Chase.
“However, we believe the underlying message will be more in line with the next move taking place in December rather than October.”
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.
