The ECB may cut interest rates continuously for the first time in 13 years! Is economic weakness the core issue?

At 20:15 Beijing time, the ECB will announce its interest rate decision. The market generally expects the ECB to cut interest rates by another 25 basis points. The reason is that inflation in the Eurozone is now more and more controlled, while the economy is stagnating.

This may be the first time in 13 years that interest rates have been cut continuously, marking a shift in the ECB's focus from curbing inflation to protecting economic growth, while the Eurozone's economic growth has lagged behind that of the US for the past two years.

According to the latest economic data, Eurozone business activity, sentiment surveys, and September inflation readings were all slightly lower than expected, which may make the ECB inclined to cut interest rates.

Following the release of these data, several policymakers, including ECB President Lagarde, hinted that interest rates might be cut again this month, causing investors to fully anticipate this move.

Holger Schmieding (Holger Schmieding), an economist at Behrenberg Bank, said: “Trends in the real economy and inflation support the argument for lower interest rates.”

Schmidin said that soaring wages “seem to be gradually disappearing” to make up for soaring food and energy prices, and the ECB may see a slight rebound in inflation before the end of this year.

interest rate

HSBC analyst Chris Hare said, “The ECB is cutting interest rates at the next five policy meetings,” including Thursday's meeting.

If interest rates are cut by 25 basis points on Thursday, then the ECB deposit mechanism interest rate will drop to 3.25%, and the money market is almost completely priced until March next year, and the bank will cut interest rates three additional times.

Hare said that a series of 25 basis point interest rate cuts until April next year will reduce the deposit mechanism interest rate to 2.25%. This level has a neutral impact on the economy, so much so that it is “slightly relaxed.” Hare's colleague Fabio Balboni, HSBC's chief eurozone economist, said that the neutral interest rate in the Eurozone in April next year will be 2.25%

When asked about the possibility of cutting interest rates more drastically, Balboni pointed out that cutting interest rates by 50 basis points is unnecessary because the overall CPI inflation rate has fallen below 2% for the first time in three years. He said, “Cutting interest rates by 50 basis points has enabled the ECB to help the economy, but as we know, the ECB also knows that inflation has not yet been defeated because potential inflation is still very high. That's why we don't expect a very steep or very long route to cut interest rates.”

Inflation and growth

The ECB can finally say that it has almost tamed the worst inflation in decades.

Eurozone CPI fell to 1.8% year on year in September. Although inflation is likely to be slightly above the ECB's 2% target by the end of this year, inflation is expected to hover around this level or slightly below 2% in the foreseeable future.

However, the economy is paying a high price for this. The ECB's forecast released last month already predicted that growth would slow to a meager 0.2% in the third quarter.

High interest rates have weakened investment and economic growth, and this has been going on for almost two years. The latest data, including industrial output and bank loans, point to a similar situation over the next few months.

The exceptionally resilient labor market is also beginning to show some cracks, and job vacancy rates have declined from historic highs.

This has inspired calls within the ECB to relax policy before it is too late.

Bank of Portugal Governor Mario Centeno (Mario Centeno) recently said: “We now face a new risk: inflation is below target levels, which could stifle economic growth, and fewer jobs and reduced investment will further increase the ratio of sacrifices already endured.”

The problem is that part of the weakness is due to structural problems, such as high energy costs and low competitiveness, plaguing Germany, which is known as the “locomotive” of European industry.

These problems cannot be solved by lowering interest rates alone, although lower interest rates can help lower the cost of capital through marginal effects.

ECB Governing Council member Isabel Schnabel (Isabel Schnabel) said, “We cannot ignore the resistance of monetary policy to growth. At the same time, monetary policy cannot solve structural problems.”

Lagarde's press conference

After the ECB announced its decision, a monetary policy press conference is scheduled to be held at 20:45 on Thursday. The oft-repeated phrase “rely on data” is likely to appear in Lagarde's statement.

Analysts will analyze her remarks to find out what ECB policymakers think and any hint of the future path of interest rates.

Schmidin said that at least, Lagarde will not “correct the market's expectations of another 25 basis point cut in interest rates” at the next ECB meeting in December.

Lagarde and her colleagues are unlikely to give clear hints on future policy trends on Thursday, and they will reaffirm that decisions will be made “meeting by meeting” based on newly released data.

However, most ECB observers believe that the ECB will cut interest rates every time it meets.

Paul Hollingsworth (Paul Hollingsworth), an economist at BNP Paribas, said: “The implicit sign is that unless the data improves, it is very likely that interest rates will be cut again in December.

Most economists also see that officials will reaffirm that “the Governing Council will keep the policy 'sufficiently restrictive' when necessary to ensure that the inflation rate reaches and remains at 2% in the medium term.”

Geographic risk

Bundesbank Governor Nagel warned that if Trump is re-elected as US President, he may plan to drastically raise tariffs, implement expansionary fiscal policies, and strict immigration restrictions, which may eventually lead to inflation.

Meanwhile, a major escalation between Israel and Iran could plunge the wider region into conflict, triggering a rise in oil prices. Policymakers will also have to weigh how China's stimulus measures will change economic outcomes in Europe.

“By 2025, there may be multiple paths for growth, inflation, and monetary policy,” Deutsche Bank analysts said in a recent report.

Euro technical analysis

Fxstreet analyst Pablo Piovano said that the possibility of testing 1.0800 is not ruled out after EUR/USD continues to decline and falls below the key 200-day simple moving average (SMA) of 1.0872. Further decline could push EUR/USD to a low of 1.0777 on August 1.

On the upside, the 100-day SMA and the 55-day SMA formed initial resistance at 1.0935 and 1.1040, respectively. Further upward, we look at the 2024 high of 1.1214 (September 25), followed by the 2023 high of 1.1275 (July 18).