Traders are almost certain that the European Central Bank (ECB) will cut interest rates this week. The question is...
The ECB may cut interest rates again this Thursday, just a few weeks after the central bank hesitated to do so.
Data shows that the economic situation in the Eurozone is worse than it was at the last policymakers' meeting, intensifying bets that the rate cut will be faster than the ones in June and September.
"If the ECB does not cut rates in October, the market will think that the central bank is lagging behind the situation and may make a policy mistake," said Mark Wall, Chief European Economist at a German bank.
Here are the five key issues that the market is focusing on:
1. Will the ECB cut interest rates this week?
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This is almost certain. Traders estimate that the likelihood of the ECB cutting rates by 25 basis points is about 90%, while last month, during the ECB's interest rate meeting, this probability was only 20%.
The unexpected contraction of business activity in the Eurozone in September led to a surge in bets for a rate cut in October, as investors worried that the ECB, which adheres to data-dependent principles, might not be able to cut rates in time.
Several policymakers have defended a rate cut in October. Even ECB President Christine Lagarde has hinted at this, stating that confidence in declining inflation will be reflected in the central bank's decision.2. Does this mean that the European Central Bank (ECB) will cut interest rates consecutively?
Wall Street economists believe so. Traders anticipate that the ECB will cut rates more than three times in the four meetings following October.
However, ECB policymakers have not fully agreed with this view. ECB Governing Council member and Bank of Finland Governor Olli Rehn reiterated that the pace and magnitude of further rate cuts will be determined by each meeting.
But AXA Chief Economist Gilles Moec said Lagarde might hint at upcoming changes and pointed to the central bank's forecasts to be released in December, "The ECB's December meeting could be the right time to truly change the narrative for the future."
3. Is inflation no longer a concern for the ECB?
Traders believe that inflation is no longer a concern for the ECB, after all, inflation had soared to over 10% two years ago but fell below the ECB's 2% target in September.
Even the stubborn service sector inflation, which particularly worried the ECB, has slightly decreased. Data from Nomura Securities shows that service sector inflation dropped to its lowest level since November 2023 in the seasonally adjusted monthly data.
Data compiled by Danske Bank indicates that derivatives used to hedge inflation risks suggest that price growth will remain below 2% starting from the first quarter of next year, which is much faster than the ECB's September forecast.Even the hawkish figure Schnabel has abandoned her long-standing warnings about the difficulty of curbing price increases.
However, service sector inflation is still at 4%, with no decline this year, and the decrease in inflation in September was mainly due to falling energy prices, so the European Central Bank has not yet declared victory.
4. Is economic growth now the European Central Bank's main concern?
This is an increasingly important concern. But unlike the Federal Reserve, the European Central Bank only focuses on inflation, so the question is whether economic stagnation will lead to inflation remaining persistently below the target level, which was the main challenge the European Central Bank faced in the decade before the pandemic.
So far, the European Central Bank believes that rising real incomes will boost consumption and economic growth, with an expected increase in the economic growth rate from 0.8% this year to 1.3% next year, but some economists worry that this assumption is overly optimistic. The German economy has already shrunk for the second consecutive year.
Moec said that if the expected rebound does not appear soon, inflation could be below the European Central Bank's target, which is a concern for some policymakers.
5. Are geopolitical risks a concern for the European Central Bank?
Yes, but economists believe that geopolitical risks are more reflected in growth.Since early last October, as the conflict between Israel and Lebanon has escalated, oil prices have risen by more than 9%, but they are still more than $10 below this year's peak.
Paul Hollingsworth, Chief European Economist at BNP Paribas, said that low inflation means that the European Central Bank can tolerate any temporary price increases driven by energy prices. "The European Central Bank's response mechanism has shifted to focus more on growth risks, so geopolitical risks will only exacerbate some of their concerns."
Crucially, the European Central Bank's interest rate meeting on Thursday is the last one before the U.S. presidential election in November.