The European Central Bank is set to leave interest rates unchanged today as inflation remains in line with its target, but a fraught trade and political outlook means it will keep alive the prospect of further easing.
The ECB halved its key rate to 2% in the year to June but has been on hold ever since, arguing that the 20-country euro zone economy is in a “good place”, even if more easing cannot be ruled out.
Data over the summer has only confirmed this sanguine view, giving policymakers time to understand how US tariffs, higher German government spending and political turmoil in France might impact growth and inflation.
This makes it likely that ECB President Christine Lagarde will once again aim to be “deliberately uninformative” about the future path of interest rates – as in July, when she batted back every question on the way forward.
But Lagarde is unlikely to close the door on further rate cuts, especially since inflation is projected to temporarily dip below the ECB’s 2% target next year, keeping alive market bets that a final “insurance” cut could come around the turn of the year.
“The risk of a more persistent inflation undershooting – which might become evident in December, when the ECB will be forecasting out to 2028 – suggests a dovish bias,” HSBC analysts said in a note.
In any case, the debate is at the margins and focuses on just a single rate cut, indicating that the ECB is done with the bulk of changes to monetary policy and rates are likely to stay around this level for an extended period.
Investors see a 50-60% chance of one last cut by next spring, even as they expect the US Federal Reserve to ease six times by the end of next year.
The key debate will be around how policymakers see risks.
Hawkish Governing Council members, who are opposed to further easing, say the euro zone economy has been unexpectedly resilient to trade tensions and that growth is well supported by buoyant private consumption.
They point to rebounding industrial production and a surge in German government spending to argue that growth will remain on a moderately upward path.
Although US President Donald Trump’s 15% tariffs on European Union imports are higher than predicted, firms are showing adaptability and the certainty of having agreed a deal offsets some of the negatives.
“Our base case remains for the economy to remain resilient, as trade induced uncertainty recedes and gives way to a more positive impulse from higher European defence and German infrastructure spending,” BNP Paribas said in a note.
But policy doves say that tariffs have yet to fully work their way through the economy and could dampen an already low growth rate, reversing the rise in consumption.
This could then weigh on prices next year, just when inflation is seen dipping below target, raising the risk that firms will change their pricing and wage-setting, thus entrenching anaemic price growth, much like before the pandemic.
The Fed’s looming rate cuts are meanwhile likely to help the euro firm against the dollar, putting downward pressure on prices.
“We expect (the ECB) to stay on hold this year, before cutting rates to protect inflation expectations early next year if inflation expectations follow headline inflation lower,” Societe Generale economist Anatoli Annenkov said.
A fresh bout of political chaos in Paris, which has pushed French bond yields sharply higher, is another headache for the euro zone’s central bank.
It has tools to intervene, but only for an “unwarranted and disorderly” rise in borrowing costs, which economists say is clearly not the case now, given France’s high debt and feeble economic growth.
Article Source – ECB to hold rates again but keep door ajar to further easing
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