The European Central Bank is set to announce a rate cut by 0.25 percentage points at its meeting on September 12, which would make it the second cut after initiating its rate cut cycle in June.
"With 85% of economists polled expecting a 25 basis point rate cut by the ECB, it's safe to say the markets will be disappointed if this doesn’t happen. When expectations are so unified though, generally it’s for a reason. In fact, two reasons that we can clearly identify," said Morningstar strategist Michael Field.
"First, the macroeconomic data that has emerged since the last ECB meeting is highly supportive of the current course of action, i.e. further rate cuts. Eurozone GDP expanded by 0.3% in Q2, not blow-out growth, but solid. Particularly when you take into account that we narrowly missed a technical recession last year.
"With half the year under our belts, economists' forecasts are pointing to growth of around 1% for the full year 2024, most definitely a step in the right direction. Next, inflation rates across Europe fell again in August; readings pointed to a 2.2% increase year over year, putting it within touching distance of the 2% targeted level."
Second, Jerome Powell's August 23 speech at Jackson Hole was unambiguous: The Federal Reserve has joined the ranks of the ECB, Bank of England and Swiss National Bank in moving to a path of rate cutting. "It now seems that the path is clear for central banks in the Western world, which only gives further backing to the ECB that the direction they set out on in cutting rates is the correct one", Field adds.
In its June meeting, the bank cut rates to:
• Main refinancing rate: 4.25%, lowered from 4.50%;
• Interest rate for the marginal lending facility: 4.50%, lowered from 4.75%;
• Interest rate for the deposit facility: 3.75%, down from 4.00%.
Is Inflation Finally Under Control?
Most economists agree that the expected cuts will be in cautious steps of 0.25 percentage points, with one more cut expected at the ECB's December meeting and some likelihood assigned to an additional step in October, as inflation is on track to meet the ECB's 2% target in 2026.
"The latest inflation data was positive and heading in the right direction. That is the big advantage in the eurozone compared to the USA," Carsten Roemheld, capital market strategist at Fidelity, told Morningstar by phone on September 3.
Still, Roemheld highlights the uncertainty surrounding the inflation trend with regard to energy prices. Brent oil prices are down nearly 20% year-on-year, despite a hot conflict in the Middle East that began on October 7, 2023. Meanwhile, European benchmark TTF gas prices have reached their highest level since December 2023 amid several outages in the global LNG infrastructure and planned maintenance in Norway.
He also points to the discrepancy between equity and bond markets. "The equity and bond markets are pricing in different developments. Falling bond yields are signalling that market participants are buying bonds to hedge their bets. At the same time, the equity markets are rising from one high to the next," he said.
Roemheld expects inflation to remain above the ECB's desired 2% level throughout 2025.
How Often Will the ECB Cut Rates in 2024?
In the base scenario, Fidelity continues to expect two interest rate cuts in 2024, with two steps of 25 basis points each in September and December. The deposit facility would then stand at 3.25% at the end of the year. Fidelity expects three more quarterly cuts in 2025, bringing the interest rate down to a targeted 2.50% in September 2025.
DWS also continues to expect two interest rate cuts in September and December this year. In 2025, rates will fall by 25 basis points each quarter until the target interest rate of 2.50% is reached in September 2025, Ulrike Kastens, European Economist at DWS, forecasts. "The ECB Governing Council will definitely want to avoid lowering interest rates too quickly and thus accepting a renewed rise in inflation," she told Morningstar in an interview on September 5.
The only thing that speaks for an additional interest rate cut in October would be a sharper-than-expected economic slump and a higher-than-expected interest rate cut in the US, according to Kastens.
She also does not expect inflation to reach the ECB's target of 2% next year. DWS forecasts an average inflation rate of 2.5% for the eurozone this year and 2.3% in 2025. After that, however, the inflation rate is likely to stabilise at around 2%, according to Kastens.
Bastian Freitag, Head of Fixed Income Germany at Rothschild & Co, said he also anticipates cuts of 25 basis points each in September and December as well as further quarterly steps in 2025. Although inflation is likely to pick up again slightly at the end of the year due to base effects, the rate is gradually moving towards 2%, he said. Risks are posed by service price inflation, oil prices, a slight increase in money supply growth and wage trends, Freitag told Morningstar on September 5.
ECB May Reduce GDP Growth Outlook
DWS's Kastens also said she expects the ECB economists to revise their forecast for GDP growth downwards at the September meeting. The central bank's June forecast stated that economic growth is expected to accelerate to 0.9% in 2024, 1.4% in 2025 and 1.6% in 2026. DWS, on the other hand, only expects the eurozone economy to grow by 1% in 2025.
How Will Interest Rate Cuts Affect Markets?
Equity markets tend to rise on anticipated rate cuts. In bond markets, falling interest rates mean lower yields, which pushes bond prices higher. Lower rates also make existing bonds, and particularly those already issued during a period of high rates, more attractive for yields.
Meanwhile cash savings rates on bank accounts will likely decrease, to the detriment of savers. Borrowers, by contrast, stand to benefit from lower rates as consumer debt and mortgages become cheaper.
