Big Fed Cut Sparks ECB Move Anticipation Among Traders, Says Reuters

By Balazs Koranyi and Francesco Canepa

FRANKFURT – A significant interest rate cut by the U.S. Federal Reserve has increased speculation about potential policy easing from the European Central Bank (ECB) in October. However, this outcome remains unlikely due to differing economic conditions between the two regions.

The ECB has already implemented interest rate cuts in June and earlier this month, and several officials at the bank have suggested the possibility of steady quarterly rate reductions to ensure a lasting defeat of inflation. Although the Fed’s swift actions may support claims that the ECB is lagging in addressing rising recession risks, the underlying economic fundamentals have not shifted dramatically, allowing more hawkish members of the Governing Council to advocate for a wait-and-see approach until December.

Dirk Schumacher, an economist at Natixis, remarked that the argument for the ECB to cut rates in October solely based on the Fed’s decision is unfounded. He noted that such reasoning would not resonate with the Governing Council. "The only way to argue that is to say that it [the Fed cut] will change euro zone data, and while that may be possible, we haven’t observed those changes yet," he said.

Market expectations have adjusted slightly, with a now estimated 35% probability of a 25 basis point deposit rate cut in October, up from 30% just a day prior. Nevertheless, December remains the more likely timeframe for any ECB action.

The ECB is expected to proceed cautiously since it has less ground to cover compared to its U.S. counterpart. Estimates suggest the ECB might need five to six more 25 basis point reductions to reach a neutral interest rate level of around 2.0% to 2.25%. In contrast, the Fed may have as many as eight adjustments to make before reaching its own neutral level, indicating that both central banks could potentially finalize their easing strategies concurrently.

Additionally, euro zone inflation currently at 2.2% could increase to about 2.5% by the end of the year and is expected to decline only gradually to the ECB’s target of 2% by late 2025, primarily due to persistent wage pressures influencing service costs. This scenario has prompted conservative policymakers to advise against hasty actions.

Slovakia’s Peter Kazimir has expressed reservations about an October cut, while influential policymakers Isabel Schnabel and Klaas Knot have previously argued for aligning rate changes with fresh economic projections, which support a more deliberate approach.

Bundesbank chief Joachim Nagel underscored the current inflation rate as not aligned with desired targets. Conservatives, who led a series of rate hikes in 2022 and 2023, are expected to maintain a majority view, which is why market expectations for ECB adjustments have not shifted significantly following the Fed’s decision.

Despite the Fed’s dovish influence, market analysts suggest that more hawkish voices will likely temper expectations for additional ECB easing. Hawks point to strong wage growth as a concern, as labor costs rose by 4.7% in the second quarter, exceeding the 3% threshold considered acceptable for maintaining inflation targets. Trade unions continue to advocate for substantial wage increases to offset real income losses.

The ECB will receive limited critical data ahead of its October 17 meeting, with key wage and growth figures being released just before the December meeting when new projections are also anticipated. This leaves policymakers relying on secondary indicators, such as surveys regarding lending and corporate intentions. For a rate cut to be warranted, these indicators would need to exhibit significant deterioration.

On the other hand, doves—primarily from southern Europe—argue for a more rapid easing of policy. Mario Centeno, the governor of Portugal’s central bank and a prominent advocate for this perspective, believes that the deteriorating growth outlook necessitates swift action to avoid undershooting inflation targets. He emphasized the importance of minimizing this risk, given the current state of the monetary policy cycle.

Doves contend that faltering growth, industrial recession, weak consumer spending, and increased savings driven by economic uncertainty all pose deflationary threats and downside risks to price growth. They argue that even if inflation rises temporarily in the coming months, the threat of runaway inflation has been mitigated, particularly due to stable energy prices.