At its monetary policy meeting on Oct. 17, the European Central Bank is likely to cut the key interest rate by another 0.25 percentage points to 3.25%. This message has been conveyed quite clearly by several council members in recent days and weeks, including ECB president Christine Lagarde and French central bank chief François Villeroy de Galhau, particularly with inflation now below target. Still, the idea that a rate cut is probably coming next week is relatively new. And some economists are questioning the likelihood of an October cut, focusing instead on the December meeting.
The ECB's target for the annual inflation rate is 2%, and in September the preliminary inflation rate fell below that level at 1.8%.
"Latest developments strengthen our confidence that inflation will return to the target level in a timely manner," Lagarde said at a European Union parliamentary hearing on Sep. 30. "We will take that into account in our next monetary policy meeting in October."
Villeroy de Galhau told the Italian newspaper La Repubblica that the ECB will probably cut interest rates in October.
Rate Cuts in October and December Likely
"With 90% of economists predicting a 25 basis point cut to the European Central Bank’s deposit rates next week, this decision seems all but nailed-on. This will be the third 25 basis point rate cut since June, the slow, methodical, climb-down in rates that the ECB had hoped to achieve", says Michael Field, European market strategist at Morningstar.
A further interest rate cut in December is also considered a done deal among experts, and money markets are currently pricing in reductions of 25 basis points for October and December.
"Inflation in Europe fell to 1.8% in September, the lowest level in more than three years, and below the central bank’s 2% targeted level. While core inflation remains higher than this, the trajectory of the number has been clearly downward, a positive sign. Unemployment in Europe sits at record lows, but high by international standards at almost 6%", Field adds.
Eurozone Inflation Could Rise Again in Q4
"As with any monetary easing program there are risks, but at this stage the risk of the economy overheating because of further rate cuts appears low. Of course, the ECB wants to tread carefully and allow interest rates to find the right level, but the direction of travel from here is clear," says Field. Economists expect ECB rates to fall to 2.5% over the next 12 months.
Konstantin Veit, portfolio manager at Pimco, points out in an interview with Morningstar that the latest comments from the central bankers are a contrast to the September meeting, at which Lagarde still hinted that the data available before December would probably not be enough to justify a rate change. The preliminary September inflation reading of 1.8% was in line with market expectations and not far from the ECB's own forecasts.
In addition, inflation is expected to rise again in the fourth quarter as previous sharp declines in energy prices drop out of the annual rates, and service inflation remained high at 4%. Economic data for the eurozone have recently been disappointing.
"I think the ECB wants to cut the key interest rate to 3% as quickly as possible from a risk management perspective, and that level is still restrictive," says Veit.
Could the ECB Hold Rates Steady in October?
Carsten Brzeski of ING also points to the wording of the ECB at the September meeting, at which a preference for a next rate cut in December seemed clear. Although Brzeski also expects the interest rate cut on Oct. 17, he does not completely rule out a surprise. After all, no ‘hard’ economic data has been published since the last meeting.
"We are far less certain than financial markets that the ECB will actually cut rates next week. The main question for the ECB will be how it interprets the distinction between data dependence and data point dependence. If all of recent data is regarded as one big data point, there is no reason to cut at the October meeting. If it is regarded as one big series of disinflationary data, it is, Brzeski wrote in a blog post on Oct. 6.
"In any case, if the ECB decides to cut rates next week, this would mark an important change in its own reaction function."
How Low Will the ECB Cut Rates?
Deutsche Bank economists have also adjusted their expectations and now expect faster interest rate cuts than they did in the summer.
"Rather than policy rates returning to neutral (2.00-2.50%) by the end of 2025, we now expect neutral rates to be reached six months earlier in mid-2025," they wrote in a research note titled 'No reason to wait’ on Oct. 1. This would mean a further interest rate cut of 0.25 percentage points at each of the four meetings in the first half of 2025.
Bastian Freitag, head of fixed income Germany at Rothschild, also expects rapid interest rate cuts. "The decline in headline inflation is not only due to falling energy prices, but also to a slowdown in core inflation," Freitag says.
"For 2025, we now expect faster interest rate cuts, possibly at every ECB meeting, until the neutral interest rate level (2.0-2.5%) is reached."
The ECB began its rate-cutting cycle in June but paused in July. At the last meeting in September, the council then cut the deposit facility rate by 0.25 percentage points to 3.5%. Since Sept. 18, the three key ECB interest rates have been as follows:
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Deposit facility rate: 3.50%, down from 3.75%
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Main refinancing rate: 3.65%, down from 4.25%
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Marginal lending facility rate: 3.9%, down from 4.50%
Other major European central banks have also initiated cycles of interest rate cuts – most notably the Swiss National Bank, which was the first of the major western central banks to rush ahead with an interest rate cut in March. Further interest rate cuts followed in June and September.
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. The rates that savers receive depend mostly on the deposit facility, which defines the interest banks receive for depositing money with the ECB overnight.
Borrowers, by contrast, stand to benefit from lower rates as consumer debt and mortgages become cheaper.
