Portfolio Manager, Managed Reserves Europe
In brief
- At its September monetary policy meeting, the European Central Bank (ECB) cut its deposit facility rate (DFR) by 25 basis points (bps) for the second time this year. The rate cut was broadly expected by the market.
- The accompanying statement struck a balanced tone, while highlighting strong wage growth and domestic inflation but also indicating the progress in bringing them down.
- At the press conference, ECB President Christine Lagarde emphasised the Governing Council’s data dependency and that it can’t commit to a specific path for the borrowing costs.
Data dependent
At its September monetary policy meeting, the ECB cut its main refinancing rate, marginal lending facility and deposit facility rates to 3.65%, 3.9% and 3.5% respectively. The ECB narrowed the spread between the main refinancing rate and the deposit rate to 15bps from 50bps. This move, which was announced in March as part of the changes to the operational framework for implementing monetary policy, was planned to come into effect in September. The narrower corridor should have little impact on the stance of the monetary policy.
Although the accompanying statement struck a balanced tone overall, there were few changes. It indicated that “domestic inflation remains high as wages are still rising at an elevated pace. However, labour costs are moderating, and profits are partially buffering the impact of higher wages in inflation.”
At the subsequent press conference, President Lagarde reiterated many times that the ECB will not commit to any predetermined pathway for the rates and will follow a data (but not data point) dependent meeting by meeting approach, neither ruling out nor committing to a cut in October. We believe there is a more probability of the ECB holding in October and cutting rates again in December. However, the risks are very finely balanced for the October meeting and the decision could be tilted to either direction depending on the incoming data.
Exhibit 1: The ECB has cut base rates for the second time since this year. The Euribor yield had flattened in anticipation of cuts
Source: Bloomberg, J.P. Morgan Asset Management, data as at 12 September 2024
New forecast are not very different to the June meeting
The Governing Council noted that “recent inflation data have come in broadly as expected, and the latest ECB staff projections confirm the previous inflation outlook.” with headline inflation declining sharply from a peak of 10.6% in the middle of 2022 to 2.2% in August 2024. Staff projections in the September meeting didn’t show material changes to the inflation outlook compared to previous projections in June. Only the core figures were revised up by 10bps for 2024 and 2025 (to 2.3% in 2025 and 2% in 2026) while the expectations for headline measures were unchanged. Inflation is expected to rise again in the latter part of this year, partly because previous sharp falls in energy prices will drop out of the annual rates.
Domestic inflation remains high as wages are still rising at an elevated pace. However, labour cost pressures are moderating, and profits are partially buffering the impact of higher wages on inflation. The forecasts for GDP growth were lowered by 10bps for every year in the forecast horizon to 0.8% for 2024, 1.3% for 2025 and 1.5% for 2026.
Exhibit 2: Disinflation process is intact but inflation remains above ECB target level; meanwhile employment and wage growth remain robust
Source: Bloomberg, J.P. Morgan Asset Management, data as at 12 September 2024.
Market reaction and fund positioning
Ahead of the meeting, the market was pricing in 100% probability of a rate cut, with an additional 1.5 cuts priced for the remainder of 2024. Following the announcement, bond yields jumped higher while the euro appreciated as the market interpreted the conference tone as slightly hawkish.
The EUR LVNAV strategy is well positioned to take advantage of the rate cut with weighted average duration (WAM) at 40-50-days range with ample holdings of fixed paper in the 6–12-month part of the curve to lock in longer tenor yields.
Conclusion
The ECB has cut its DFR by another 25bps while providing minimal forward guidance. Although the ECB appears increasingly confident in the disinflation process, it chose to retain maximum optionality for the next meetings with data dependent meeting-by-meeting approach. However, the central bank has clearly indicated that interest rates are set to decrease.
For EUR cash investors, the rate cut will likely trigger lower deposit rates, however money market funds with longer duration strategies should continue to offer competitive returns for the foreseeable future.
Source for all data is Bloomberg, J.P. Morgan Asset Management, as at 12 September 2024, unless otherwise stated.
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