We believe that the ECB will continue its rate cutting cycle in September

Comments by Michael Krautzberger , Global CIO Fixed Income at AllianzGI, ahead of the European Central Bank (ECB) meeting on 12 September:

• We expect the European Central Bank to cut rates by a further 25bp at its September 12 meeting and to revise down its 2024 and 2025 growth and inflation forecasts
• Market impact is anticipated to be limited. But it would mean interest rate differentials versus Japan would continue to come down which may result in continued higher FX volatility recently and might continue to do so
• Until recently the market consensus was clearly that December would see the next cut after this one. With the weakening in the US labour market and increasing talk of a possible 50bp US Federal Reserve cut an October move cannot be excluded

Softer global inflation readings have so far vindicated the European Central Bank, which was the first major central bank to cut in this cycle and we expect the next 25bp cut on 12 September. Both economic growth and inflation overall came in weaker than expected by the ECB over the summer.

We therefore expect the ECB staff forecast to revise modestly lower its 2024 and 2025 growth and inflation forecasts.

Interestingly, not only has realised inflation come down – wages have also surprised the ECB on the lower side and forward inflation expectations have fallen back to its inflation target. This is in stark contrast to the sentiment at the beginning of the year when many commentators were speaking about “higher for longer inflation”. Now, the inflation markets make it possible to hedge against such a scenario without much of a risk premium. Therefore inflation protection is slowly becoming more interesting again.

On the other side of the Atlantic, after two weaker-than-expected labour market reports and downward historic revisions, the interest rate market is slowly giving a 50bp cut a higher probability than 25bp. Should a 50bp move indeed happen, the international context would also put pressure on the ECB not to wait for three months after September before the next move. In our view, an October move is still not the main scenario but can no longer be excluded. One argument here is that current interest rates near 4% are clearly very restrictive and the current data mix requires more neutral interest rates around 2% to be reached sooner than later.

For now, we remain positioned in yield curve steepening trades and are constructive on duration but would reduce this somewhat in the event of a 50bp move by the US Federal Reserve.

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