The decline in rates has more legs

The significant decline in rates through August and September was followed by increases in October, particularly in the US where rates have risen sharply. The 10-year US Treasury yield is up by nearly 0.5 percentage points over the last month, driven by multiple factors: key indicators in the US economy show renewed strength, and simultaneously, the term premium in long-term rates has increased due to growing expectations of a Republican Sweep at the 5 November elections. In the euro area, fluctuations in rates have been more moderate, leading to a noticeable decoupling from the US.

Forecast revision: ECB rates will be cut faster and to a lower level

In the euro area, the ECB delivered its expected third rate cut of 25bp this year, bringing the deposit rate down to a new level of 3.25%. However, what was remarkable was the clearly more negative outlook on the economic dynamics in the region. Activity indicators have shown marked weakness in the second half of the year, and inflation dynamics continue to move in the right direction. This provides greater flexibility to worry about the risk that inflation could ultimately end up below the target of 2%. The hawks within the ECB can still rely on high service inflation, low unemployment in the region, and economic strength in Southern Europe. But it is clear that these arguments have lost some of their weight recently. The clearest example of this is the increasingly open debate about not just delivering a 25bp rate cut, but a full 50bp – at the upcoming meeting in December. If this happens, it will, in our view, be a clear signal that the ECB intends to deliver more cuts of that size and also aims for a significantly lower end point for the policy rate level next year than previously assumed. Following the recent changes in signals from the ECB, we have significantly adjusted our profile for the policy rates downwards. We now see rate cuts of 25bp at each meeting until September 2025, with a risk that the pace could increase along the way. Our endpoint for the key ECB deposit rate thus becomes 1.5% compared to the previous 2.0%. The lower terminal rate should not be seen as a reflection of a significantly more negative view of growth prospects, but rather that the ECB members’ drastic shift in focus from inflation to growth concerns has increased the likelihood that monetary policy will be moved into moderately accommodative territory.

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