The European Central Bank (ECB) reduced the Deposit Facility Rate by 25 basis points (bps) to 3.0% today amid easing inflationary pressures and faltering growth. The rate cut also marks the central bank’s fourth rate reduction this year, with the interest rate at its lowest since early 2023. This also followed the Swiss National Bank surprising markets earlier today and cutting its overnight rate by 50 bps to 0.50%.

The ECB also reduced the Main Refinancing Rate and the Marginal Lending Facility Rate by 25 bps to 3.15% and 3.4%, respectively. There was speculation that the ECB could opt for an outsized 50 bp cut on the back of a series of recent soft growth metrics, which is something ECB President Christine Lagarde touched on in her press conference.

In terms of the central bank’s language, the ECB’s rate statement struck a modestly dovish tone, dropping the sentence highlighting that it would ‘keep policy rates sufficiently restrictive for as long as necessary’, which I believe, along with the downward revision to both growth and inflation metrics, were the primary drivers behind the initial move lower in the EUR. Regardless, the immediate reaction was nothing to write home about. In fact, it felt like a ‘sell-the-fact, buy-the-rumour’ setup was at play here, with investors shorting into the risk event and liquidating positions following the announcement.

The rate statement added that the central bank is ‘determined to ensure that inflation stabilises sustainably at its 2% medium-term target’, marking a change from the previous meeting’s sentence: ‘determined to ensure that inflation returns to its 2% medium-term target in a timely manner’. The ECB also added: ‘Over time, the gradually fading effects of restrictive monetary policy should support a pick-up in domestic demand’, but maintained that it will continue to adopt a meeting-by-meeting approach to determine policy.

As I briefly noted above, the updated quarterly projections from ECB staff on growth and inflation measures were revised lower.

On the GDP growth front (Gross Domestic Product), the economy is now expected to grow at a slower pace, by 0.7% in 2024 (down from 0.8% in previous projections), 1.1% in 2025 (from 1.3%) and 1.4% in 2026 (from 1.5%).

CPI Inflation (Consumer Price Index) is expected to average 2.4% this year (down from the previous projection of 2.5%). It is also forecast to further slow to 2.1% in 2025 (from 2.2%) and then cool to 1.9% in 2026 (unchanged from previous projections). For core CPI inflation, 2024 and 2025 projections were unchanged at 2.9% and 2.3%, respectively, though 2026 was revised to 1.9% (down from 2.0% in the previous projection).

ECB’s Christine Lagarde: ‘Direction of Travel is Clear’

In her press conference, ECB’s Lagarde commented that despite some support for a bulkier 50 bp rate cut, the Governing Council unanimously settled for a 25 bp decrease.

Lagarde also told reporters that the ‘direction of travel is very clear’ and expressed that a lot of ground has been covered’. However, she noted that the central bank ‘wants to see a change in the composition of inflation to feel totally confident that we are really almost at target [the 2.0% medium-term inflation target]’. Lagarde added that the central bank is not yet declaring victory against inflation but said that inflation was on the right track.

The ECB President expressed that ‘risks to economic growth remain tilted to the downside’ but said that ‘the economy should strengthen over time, although more slowly than previously expected’.

Unsurprisingly, Lagarde avoided offering any forward guidance and repeated that the central bank is not committing to a particular rate path and will make decisions based on a meeting-by-meeting approach to determine the pace of easing.

Further Rate Cuts Ahead: 125 Basis Points?

Barring anything unforeseen, we will see further cuts in early 2025, albeit likely gradual, incremental 25 bp reductions. Markets are currently pricing in another 125 bps of cuts by September 2025, a move that would take the deposit rate to 1.75%.

However, some desks feel the focus has shifted to whether the central bank is doing enough to support the eurozone economy, which is clearly lagging the US and the UK, and they believe the ECB needs to pick up the pace of rate cuts.

Market participants, therefore, are expected to keep a close eye on potential indicators of economic challenges, particularly as concerns have heightened due to policy inaction in Germany and political stalemate in France. Such indicators could imply the likelihood of more substantial interest rate reductions in the coming year.

Written by FP Markets Market Analyst Aaron Hill