ECB Insight: With Council Support Not Complete but Sufficient, ECB to Cut by 25BP and Promise Nothing

15 October 2024

By David Barwick – FRANKFURT (Econostream) – European Central Bank President Christine Lagarde might be well advised to resist her usual instincts and refrain from seeking unanimous support for the rate cut we expect to emerge from this week’s Governing Council meeting.

Not that we think unanimity is likely anyway, with a number of Council members having abstained to the end from jumping on the rate-cut bandwagon, and with reasons to be sceptical about doing so, as described here on Friday. Indeed, the 23.3bp of easing priced in by markets as of this moment may be too euphoric, but it is late for the ECB to indulge second thoughts.

In any case, a clear lack of unanimity would be a convenient way of forestalling financial market exuberance that even proponents of a cut may be leery of triggering.

If, as we anticipate on balance, a slightly hawkish cut it is to be, what other options does Lagarde have aside from pointing to a lack of universal support? Not many, assuming she upholds the data-dependent, meeting-by-meeting approach - as most Council members seem to want.

Developments support this. Had the ECB indicated too strongly last month that it was sure of cutting again only in December, or downplayed the possibility of moving at non-projection meetings in general, it would now find itself straitjacketed, though one could apply the same logic in arguing that its having played up the idea of an October cut leaves backing out of one difficult.

As Chief Economist Philip Lane noted in Luxembourg on September 16 in discussing how the ECB might need to adapt to data at odds with its baseline: ‘These considerations reinforce the value of a meeting-by-meeting and data-dependent approach that maintains two-way optionality and flexibility for future rate decisions.’

Lagarde may say that there will be no automaticity about December and that everything is open. At the very most, she might add that the October cut will be taken into account in December. All of which goes without saying, just like her key statement before EU Parliament on 30 September, which all the same naturally stoked rate cut expectations.

We don’t envision it taking much more than that to push this cut through. A significant number of Council members have signalled enthusiasm for cutting, and given the limited cost if it turns out to have been unnecessary, and the embarrassment of reneging on so much public encouragement, the arguments for a cut should win over enough fence-sitters, though not all.

In particular, it would be natural for the ECB’s thinking to resemble that of Sweden’s central bank in cutting interest rates last month, absent the latter’s fondness for forward guidance.

‘The risk of inflation becoming too high has gradually declined’, the Riksbank said.’ At the same time, the recovery appears to be proceeding somewhat more slowly than expected. It is important in itself that economic activity strengthens, but it is also a necessary condition for inflation to stabilise close to the target.’

To see the ECB’s version of this, one need only look again at Lane’s September 16 speech, in which he explained the circumstances under which the ECB could go more quickly, namely if activity data came in weaker than expected or if there were a downside surprise on inflation.

The key thought, inserted parenthetically, came when he spoke of ‘a material shortfall in the speed of economic recovery (with its associated implications for medium-term inflation)’. In other words, to deliver 2% inflation in the medium term, the economy can’t be too weak.

The easy objection to cutting is the lack of a full set of updated macroeconomic projections to clearly corroborate developments. Still, based on data that are available, concern about the ECB’s ability to ensure stable medium-term inflation at target seems legitimate enough for cutting arguments to deserve traction.

Policy hawks’ comments well before the Council meeting confirm this, with Latvijas Banka Governor Mārtiņš Kazāks clearly in favour of cutting. Others have left things open whilst sounding more dovish than usual, be it De Nederlandsche Bank Governor Klaas Knot, Bundesbank President Joachim Nagel or Executive Board member Isabel Schnabel.

For Knot, this is a prime opportunity to burnish the not-so-hawkish-after-all credentials he hopes will stand him in good stead with peripheral countries when the next ECB Executive Board position opens up.

Meanwhile, Schnabel and Nagel are German. Though tasked with setting policy for the whole euro area, they are painfully aware of Germany’s difficult economic situation. Even if the reasons are structural, it is hardly conceivable that Germany relishes its traditional role of bulwark against loose money at the moment.

All that said, a major surprise isn’t impossible. A sizeable list of Council members behind whose name a question mark still stands is too easy to compile to disperse the uncertainty.

Moreover, the ECB will have data not yet publicly available, though we do not suggest that these are likely to contradict what we now know; they could just as easily substantiate it yet more strongly.

As for December, the last five weeks have already delivered dramatic evidence of how quickly things can head in an unexpected direction. Slightly hawkish though Thursday’s cut may need to be, we would on balance expect another one in two months. But we are far from being ready to bet the house on it.