ECB’s Cautious Rate Cut Stance May Shift to Aggressive Amid Shallow Recovery: BofA

The European Central Bank (ECB) is taking a cautious stance regarding rate cuts, yet Bank of America (BofA) anticipates that the ECB will ultimately be compelled to implement deeper reductions than currently projected. This action may be necessary to mitigate a weak economic recovery and to address inflation falling short of its target.

BofA economists highlighted in their latest Euro Area Viewpoint that they foresee more cuts in 2025 and 2026 than what the markets are currently pricing, predicting a return to a deposit rate of 2% by the third quarter of 2025, with a further reduction to 1.5% by 2026.

The outlook for the economy is central to this dovish prediction; a further decline in economic activity could prompt the ECB to cut rates as early as October 2024. The economists noted that cumulative cuts of 50 basis points in 2024 represent a conservative estimate.

According to BofA, Europe’s recovery is fragile and will likely be shallow due to various factors, including slowing growth in China and ongoing political issues. They noted that sentiment is deteriorating, the labor market is losing some of its strength, and savings rates are on the rise. The potential negative impacts of political uncertainty are believed to outweigh minor fiscal slips.

In light of sluggish anticipated economic growth, inflation is expected to fall below the central bank’s 2% target. BofA forecasts euro-area core inflation rates of 2.8%, 1.9%, and 1.8% for 2024, 2025, and 2026, respectively.

While the ECB is remaining cautious about reducing rates, the likelihood of inflation undershooting its target will likely compel the bank to lower rates towards their “neutral rate assumption” in 2025, with further cuts in 2026 noted as part of BofA’s base case scenario.