In brief
- At the conclusion of its October monetary policy meeting, the European Central Bank (ECB) cut its Deposit Facility Rate by 25 basis points (bps) for the second consecutive meeting. The decision marks the first time the ECB has voted for back-to-back rate cuts in over a decade.
- The accompanying press release was dovish, stating that although there will be a temporary increase in inflation, it will then decline to target during the course of 2025.
- At the press conference, ECB President Christine Lagarde emphasised the Governing Council’s data dependence, and reiterated that it won’t commit to a specific path for policy rates.
Data dependency remains key
Following its October monetary policy meeting, the ECB cut all of its policy rates by 25bps. From 23 October, the Marginal Lending Facility will fall to 3.65%, the Main Refinancing Rate will be 3.40%, and the Deposit Facility Rate will be 3.25%.
In the aftermath of September’s meeting, the market had little conviction of any rate reductions in October and instead forecast that the next cut would occur in December. However, recent inflation data has printed lower than the initial forecasts, and forward-looking economic survey data points towards increased downside risks for growth.
For much of 2024, ECB President Lagarde has repeatedly reinforced the data-dependent nature of the Governing Council’s decisions. While an October rate cut appeared unlikely just five weeks ago, the data has changed, paving the way for rate reductions. Slowing global economic demand, and additional headwinds from geopolitical events, could subdue price pressures. However, elevated wages and the recent Bank Lending Survey, which indicated a balanced outlook across different facets of the credit standards across the eurozone, suggest the region could avoid recession.
At the subsequent press conference, Lagarde reiterated many times that the ECB will not commit to a predetermined pathway for rates, but instead will analyse the data, without being tied to any one specific data point. In the aftermath of the meeting, the market is, on average, pricing in a further 25bps rate cut at each of the next five meetings, which would take the eurozone deposit rate to 2% by the end of June 2025. Many economists have predicted that 2% is the neutral rate across the eurozone, which would indicate that the market, by forecasting additional cuts beyond the next five meetings, may be pricing in an overly pessimistic economic outlook.
New Staff Forecasts will be available for December’s meeting, in addition to third-quarter jobs and wage data.
Market reaction and fund positioning
Between September’s meeting and today’s decision, the market shifted dramatically regarding the likelihood of further monetary policy loosening. Initially, a 25bps cut at the December meeting was almost fully priced in, but directly after the press conference there was a 20% chance of the ECB cutting by 50bps. Following the announcement, the euro declined against the US dollar. The EUR LVNAV strategy is well-positioned to benefit from the rate cut, with a weighted average duration (WAM) in the 40-50 day range and ample holdings of fixed paper in the six- to 12-month part of the curve to lock in longer tenor yields.
For euro cash investors, the rate cut will trigger lower deposit rates at the start of the next Reserve Period (23 October). However, money market fund strategies with longer durations will shield investors from the full impact of lower rates in the medium term.
Conclusion
The ECB has cut its Deposit Facility Rate by another 25bps, adhering to its data-dependent mantra. While the ECB won’t declare victory over inflation, policymakers have been surprised by the sharper-than-expected decline in economic data and inflation. The focus will now be on ensuring that growth does not deteriorate further, potentially pulling the eurozone into a recession.