ECB Insight: In Which We Change Our October Call: Governing Council to Cut

30 September 2024

By David Barwick – FRANKFURT (Econostream) – Last Thursday we outlined a path for the European Central Bank’s Governing Council to cut interest rates in October rather than wait until December. Still, an October cut was, we wrote, ‘no given yet, though the odds have clearly risen.’

That has changed, and we now expect a cut.

Our analysis identified at least nine Council members likely to support such a move without needing any additional persuasion. We left open whether Chief Economist Philip Lane – and by likely extension President Christine Lagarde and Vice President Luis de Guindos – would also favour further easing.

We now feel that the potent combination of faster-than-expected disinflation and worse-than-expected activity has acquired a certain invincibility that leads us to discount a scenario in which a cut would depend mainly on how hard a minority of national central bank governors can push for one.

Rather, we would expect the preponderance of evidence to induce ECB leadership to support further easing, with the endorsement of at least some national central bank hawks, making a cut in October close to inevitable from the current perspective.

It is possible that the cut will not be quite everyone’s preferred option. Still, there are reasons not to exclude that it will garner overwhelming support.

One is the obvious attachment of policymakers of nearly all stripes to the now-teetering ideal of a soft landing. Another is the importance of economic activity for maintaining a healthy rate of inflation, an argument that should transcend hawk-dove lines, as hardly anyone would be keen to return to a lowflation environment.

It is worth noting that, against a backdrop similarly composed of diminished upside inflation risks and a slower-than-expected recovery, Sweden’s Riksbank justified its rate cut last Wednesday precisely by highlighting the link between economic activity and the desired level of inflation.

‘It is important in itself that economic activity strengthens, but it is also a necessary condition for inflation to stabilise close to the target’, the Swedish central bank said in what is likely to be a foretaste of ECB messaging. ‘Consequently, it is assessed that the policy rate can be cut at a faster pace than the Riksbank has previously communicated.’

Putting ourselves in the position of those who decide monetary policy in the euro area, we fail to see how, from a risk management perspective, an October cut would not appear clearly preferable, given the low cost of frontloading a future cut and the potentially high cost – in terms of economic pain and undershooting the inflation target – that a delay could entail.

In terms of communication, the ECB cannot be said to have created meaningful obstacles for itself to the option of an October cut. The very slight hints at the level of the Executive Board favouring December all date from the immediate aftermath of the Governing Council’s last monetary policy meeting, at which time there was no compelling reason to expect anything for another 12 weeks.

Even those who subtly flagged December generally left October entirely open. What for, if not to react to the potential changes?

As Lane said two weeks ago in a speech in Luxembourg, ‘if the incoming data indicate a sustained acceleration in the speed of disinflation or a material shortfall in the speed of economic recovery (with its associated implications for medium-term inflation), a faster pace of rate adjustment may be warranted’.

Or as Lagarde said three days before that, ‘if there is a significant change relative to our baseline, we’ll reassess.’

It remains only to be seen whether data yet to come corroborate the steadily increasing perception that indeed there has been a change, or even two, to borrow from Lane’s speech: both an acceleration of disinflation and a (further) delay in the recovery.

Here outsiders are condemned to remain partially in the dark until after the fact, which is the main reason we consider a cut not quite absolutely certain.

While some information, including the latest inflation figures, will be well publicised in advance, other data won’t even be at the disposal of Governing Council members until close to or during the meeting.

Much of the survey information will only be made generally available after the 17 October meeting, such as the Survey of Professional Forecasters (expected 18 October), or the Corporate Telephone Survey, in which the ECB gathers business intelligence from non‑financial companies (presumably to be shared in the Economic Bulletin some two weeks after the Governing Council has met).

However, a decision not to cut rates would probably require that the data that only the ECB has tell a very different story from that told by public information. And it is unlikely that non‑financial companies, for example, will have reported over the phone that in fact everything is going swimmingly and the gloomy PMIs were just wrong.

No one, as we wrote last Thursday, should think that the ECB will feel paralysed by any lack of information.

As Lane made clear in a speech in May, ‘the net interpretation of the incoming data at a non-projection meeting can result in several possible outcomes’, one of these being ‘a further boost to the level of confidence in the sustainability of convergence to the target and/or increased evidence of adverse economic side effects from the level of restriction’.

There should be little doubt, if developments up to today are not stunningly contradicted by incoming information over the next two and a half weeks, that this will be precisely the outcome of the ECB’s analysis on 17 October, and that the Governing Council will deem it appropriate to address this undesirable change in the environment by easing monetary policy further without delay, presumably by 25bp.