ECB takes rate pause without guidance, as expected

Confirmation of the KBC Economics scenario

The pause in the easing cycle was in line with the KBC Economics scenario. The ECB feels its medium-term inflation outlook is broadly confirmed by the recent economic data, but it remains vague about the further timing of the easing cycle. It underlined that further decisions remain entirely data-dependent and will be considered in a meeting-by-meeting approach. ECB President Lagarde was clear: she reiterated twice that the ECB does not commit to a particular rate path over time.

That wait-and-see stance has much to do with the persistence of core inflation (mainly driven by the services component) in June at 2.9% year-on-year, rebounding from 2.7% in May and breaking a downward trend. Wage growth in the euro area is also currently higher than is compatible with the longer-term inflation target. However, according to the ECB, these high rates of wage growth are temporary and reflect, with the usual lag, past wage inflation adjustments. The same reasoning implies that, with the usual lag, wage growth will again decline in 2025 and normalize to levels compatible with the 2% inflation target. Moreover, the current inflationary impact of wage pressures is partially absorbed by corporate profit margins.

Thus, policy rates in the euro area remain on track. We confirm our expectation that the ECB will cut its deposit rate twice more in 2024, in September and December, by 25 basis points each time to 3.25% by the end of 2024. In the first half of 2025, the deposit rate is likely to bottom out in this cycle at 2.75%, which KBC Economics considers to be the current neutral equilibrium rate. Plausible timings for those rate cuts in 2025 are the policy meetings when new macroeconomic ECB projections will be available, in other words March and June 2025.  

For completeness, as of September 2024, the ECB's new operational policy framework will take effect. Specifically, this means, among other things, that the spread between the refinancing and deposit rates will be 15 basis points. Since we expect the ECB to cut its deposit rate by 25 basis points in September, this means that the refinancing rate will fall by 60 basis points in September. Of this, 25 basis points will be driven by the policy change, while the remaining 35 basis points reflect the one-off operational transition of the spread from the current 50 to 15 basis points.

Financial market expectations are closely in line with KBC Economics' scenario. Hence, German 10-year bond yields and the US dollar to euro exchange rate barely reacted to the interest rate decision. Also, the two interest rate cuts by the ECB by 25 basis points each in September and December, respectively, are almost fully priced into market expectations.

Interpretation

Despite today's pause in the easing cycle, the ECB still remains ahead of the Fed and the Bank of England. Perhaps all three central banks will cut their policy rates by 25 basis points in September, thus ushering in an as-yet relatively synchronous global easing cycle.

An ECB rate cut in September is very likely, despite the fact that the ECB again avoided explicit forward guidance today. After all, September has updated macroeconomic ECB projections. That is important new information for the ‘data-dependent’ ECB on the robustness of the further disinflationary path. 

In summary, even after today's interest rate pause, the ECB's easing cycle remains intact. Indeed, the current deposit rate level of 3.75% is still distinctly restrictive (higher than the neutral rate) and would remain so even after another rate cut. This is currently still appropriate, given the (probably temporary) break in the downward trend of headline inflation. However, as headline and underlying core inflation resume their downward trend toward 2%, the ECB will cut its policy rate further and is likely to reach its neutral rate by 2025. But the risks around the interest rate scenario remain rather on the upside.