ECB preview: Dialling back, but pace uncertain

• On Thursday 12 September, the ECB is widely expected by both analysts and markets to deliver a 25bp rate cut. The moderation in the labour market and economic activity since the June meeting should fuel confidence in the disinflationary process being on track, in particularly given the slowdown in wage growth.

• We expect Lagarde to confirm that that it is entering the dialling back phase, but we do not expect a commitment to a specific timing of further rate cuts; thus, we do not anticipate that it will deviate from the meeting-by-meeting and data-dependent approach to the policy rate changes, thereby keeping its guidance’s optionality and flexibility.

• The updated September staff projection is expected to be largely unchanged, which is expected to lead to a cautious approach by the ECB. We will pay attention to the staff’s projections on wages and productivity, on top of the inflation projection, in order to assess ‘Lane’s formula’.

September cut seems given, but pace uncertain

Data over the past weeks have overall supported the case for further rate cuts from the ECB. Excluding the one-off boost from the Olympics, soft indicators have weakened over the summer, while the labour market is showing signs of moderation as seen in the stagnation of the PMI employment measure and decline in negotiated wage growth. So, while the domestic inflation indicator is still at elevated levels around 4.3%, the totality of data still speaks in favour of a rate cut next week. The question then becomes at what pace and to where.

A risk of an October cut

Historically, once central banks start cutting rates, the easing path has been relatively quick, at least to the top end of the neutral rate. According to Reuters this discussion has flared up in the ECB and not least to what level the neutral rate is. Previously, the 3% mark has been mentioned as the top end of neutral estimates. Importantly, we need to recall that episodes of policy easing have historically coincided with economic downturns. This is not the base case today. However, with global central banks shifting focus to the risk of excessive monetary policy restrictiveness, markets have started to speculate on the possibility of an October cut from the ECB. While an October rate cut could happen in a downside scenario, not least influenced by the totality of data and an aggressive Fed cutting cycle, we think it is unlikely that the incoming information between the September and the October meeting will be sufficiently weak to bring an October rate cut in play, unless Lagarde already next week clearly communicates this to be the baseline. Domestic inflation (services) remained elevated in August, and this will most likely keep ECB hawks on the defence in terms of changing the gradual approach. Our expectation for the staff projections does not allow for an October cut being the new baseline either. According to ‘Lane’s formula’ it is expected to show a positive gap and the risk of headline inflation may only reach 2% in late 2025/ early 2026.

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