ECB Insight: Case for October Cut Gaining Ground Among Governing Council Members

26 September 2024

By David Barwick – FRANKFURT (Econostream) – We have tended to believe, with a certain conviction, that the European Central Bank’s Governing Council would stick for the time being to a quarterly pace of easing, so that the next rate cut would be in December rather than October.

A sentence we wrote the morning after the 12 September press conference reflected our attitude: ‘We continue to think that, barring a significant change in the environment that might be hard to capture in numbers by the time of the October meeting, given the relatively short time until then, the next move is likely to be another 25bp cut in December.’

The condition we expressed there for an October cut was echoed later that day by ECB President Christine Lagarde when she asserted that ‘if there is a significant change relative to our baseline, we’ll reassess.’

One might ask whether, given less information available at a non-projection monetary policy meeting, especially a mere 35 days after the previous projection meeting, the analysis done on this more tenuous basis could support the assessment of whether a ‘significant change’ with respect to the baseline had occurred.

The answer is yes. To be sure, under such circumstances there could be greater uncertainty about the robustness of the analysis and thus more room for disagreement. All the same, the ECB can certainly determine on 17 October that a ‘significant change’ appears to have occurred relative to its 12 September baseline, and not just in the trivial case of an obvious shock (which there has not been).

As to the question of whether there has in fact been a ‘significant change’, or at least whether enough Council members would say so, it is undeniable that, fuelled by last week’s feeble PMIs, concerns about the economic outlook are moving to the forefront of policymakers’ minds.

We are nonetheless hesitant to subscribe too quickly to the idea that the ECB will cut rates on 17 October. At this point, it is simply not clear to us that a majority of the Council would be persuaded of the need, though this can change.

If the next Governing Council monetary policy meeting were held today, then by our count, at least nine members would probably arrive in a frame of mind conducive to cutting. They are:

Banco de Portugal Governor Mário Centeno
Banca d’Italia Governor Fabio Panetta
ECB Executive Board member Piero Cipollone
Bank of Greece Governor Yannis Stournaras
Central Bank of Cyprus Governor Christodoulos Patsalides
Bank of Finland Governor Olli Rehn
Banque de France Governor François Villeroy de Galhau
Banco de España Governor José Luis Escrivá
Central Bank of Malta Acting Governor Alexander Demarco

We wouldn’t object if someone wished to include ECB Chief Economist Philip Lane in that list, though this is somewhat of a wildcard. Arithmetically that would still be fewer than half of the Council, but on the other hand, Lane is more equal than others.

Moreover, including Lane seems almost tantamount to including Lagarde herself and quite possibly ECB Vice President Luis de Guindos. Seen that way, the potential for an October cut suddenly looms very large, and that with three weeks still to go during which data may continue to call the current baseline into question.

In any case, it seems likely that the tone will become more dovish. If there is no 25bp cut, then it is hard to believe that it would remain data-driven, meeting-by-meeting business as usual.

Rather, Lagarde would have to throw what we have seen could be nearly half the Governing Council a large bone and hence be clearer about the likelihood of a cut in December and about the ECB’s potential readiness to cut by more than 25bp.

This scenario would imply a departure from the approach the ECB has been adhering to lately, but the abrupt materialisation of substantial downside risks to growth would be the sort of circumstance deemed to warrant this.

But even if there were a cut, then given the growth concerns that would be driving it, Lagarde would certainly not pretend that the ECB had merely done its Christmas giving a bit early and that’s it, party over. Rather, she would probably encourage the expectation of another gift come 12 December.

The least likely scenario from today’s perspective is that of no change either as regards interest rates or in terms of communication. This seems unlikely, given the extent to which worries about growth, flanked by continued confidence in disinflation, have gained traction.

In other words, the perception of a change relative to the baseline is probably sufficient in any case as of right now to alter monetary policy going forward.

Whether to such a degree as to induce the ECB to cut rates in October is for us no given yet, though the odds have clearly risen. With exactly three weeks to go, the final answer will probably be written in incoming data.

Business and consumer confidence on Friday, unemployment next week and then industrial production and ZEW on 15 October – all of these may play a larger-than-usual role in determining the outcome on 17 October.

And of course, there is the supporting role of inflation developments, which is key. As Latvijas Banka Governor Mārtiņš Kazāks remarked on 13 September, ‘[I]f the economy feels significantly weaker than is currently expected and inflation also significantly declines, then of course we could also consider a rate cut’ in October.

That is, some Council members may hesitate to support an October cut solely on the basis of somewhat uncertain evidence of unexpected economic weakness, against the backdrop of still-high wage growth and services inflation.

Clear evidence of continued disinflation – which come December would lead them to support more easing anyway – could easily mitigate that hesitancy.

At that point, frontloading one small rate cut just to be on the safe side – think September 2023, when the ECB took out ‘insurance’ of the opposite kind – becomes relatively easy to imagine.