- The ECB decided to cut its three policy rates by 25bp, in line with market expectations. The most important decision taken today, though, was to remove the pledge to keep monetary policy restrictive. The ECB now simply guides that it will use the three-tiered reaction function inputs as key metrics (inflation outlook, underlying inflation and strength of monetary policy transmission) to set its policy rates.
- Markets didn’t take a specific cue from today’s press conference and continue to price 125bp of rate cuts in 2025.
Removing the hawkish bias
Today’s decision was not clear cut, in our view, as the ECB could have opted for a 50bp rate cut in light of the weak economic growth outlook. However, staff projections showing inflation at target made it conclude that a 25bp rate cut was sufficient.
The decision was a dovish 25bp rate cut though, and we assess the communication around it to be as close as possible to 50bp without delivering such a cut. Lagarde also said that there were deliberations about a 50bp rate cut today. Overall we found the language on growth, labour market and underlying inflation on the dovish side. In particular, we highlight that Lagarde said that the risk to inflation is now ‘clearly’ two-sided.
While Lagarde didn’t provide guidance on the end point of the rate cutting cycle, nor about the size of rate cuts at a particular point in time, the policy rate outlook is linked to the three-tiered reaction function (inflation, underlying inflation and transmission mechanism). Lagarde said they didn’t discuss the neutral rate level, but referenced the study from earlier this year that pointed to a range of neutral real rate between -0.5% and 0%, thus they will discuss once they come closer. She said that conventional wisdom suggests that the neutral rate is probably a little higher than before.
Lower growth in the staff projections and downside risks
Lagarde highlighted that the economy grew more than expected in Q3 mainly due to oneoffs from tourism. More importantly, she said that the economy is now losing momentum as manufacturing activity continues to decline and services growth is slowing down. The labour market remains solid, but she noted that vacancies are falling, and surveys point to less job creation.
The new staff projections were revised down across the entire forecast horizon on growth and see downside risks to the projections. GDP growth is now expected at 0.7% y/y in 2024 (from 0.8%), 1.1% in 2025 (from 1.3%), 1.4% in 2026 (from 1.5%). For the first time, the staff also projected 2027 growth, which is seen at 1.3%, in a sign of the ECB may be adjusting the potential growth in the euro area. The increase in growth next year is mainly driven by rising real incomes that will support consumption. Rising global demand will also help the economy in the absence of large trade disruption.
The disinflation process is well on track and inflation risks are “clearly two-sided”
In terms of inflation, the staff projections made a small downward revision to the headline forecast while the forecast for core inflation was left unchanged. Importantly, Lagarde noted that risks are “clearly two-sided”, which shows that the ECB is increasingly acknowledging that inflation could undershoot the target. Headline inflation is now expected at 2.4% y/y in 2024 (from: 2.5%), 2.1% y/y in 2025 (from: 2.2%), 1.9% y/y in 2026 (from: 1.9%) and 2.1% in 2027. The ECB said that the disinflation process is well on track and that most measures of underlying inflation suggest that inflation will settle at around the 2% target on a sustained basis. The new staff projections see core inflation at 2.9% in 2024, 2.3% in 2025, 1.9% in 2026, and 2.1% in 2027 like in September. The ECB notes that domestic inflation remains high, but that it is mostly due to wages and prices in certain sectors that are still adjusting to the past inflation surge with a significant delay. Hence, compared to earlier communications the ECB now clearly downplays the role of elevated domestic inflation and focuses more on forward looking measures, which is a dovish signal. She also highlighted lower market-based inflation measures. Another dovish communication on inflation was that Lagarde said that lower wage growth and higher productivity in staff projections means unit labour costs are expected to increase less than previously expected.
