We expect the ECB to pick up the pace of rate cuts in October

Comments by Michael Krautzberger , Global CIO Fixed Income at AllianzGI, ahead of the European Central Bank meeting on 17 October:

• We expect the European Central Bank to cut rates by a further 25 bp at its 17 October meeting, taking the deposit rate to 3.25%, thereby cutting rates in back-to-back meetings, representing a pick-up in the pace of easing.
• Comments from ECB board members have reinforced expectations of an October rate cut as euro area growth continues to deteriorate since September’s ECB policy meeting, while inflationary pressures also remain on a moderating path.
• The ECB is likely to stress that further decisions are data dependent, but we regard a further cut in December as highly likely.
• The cuts are likely to reinforce the yield curve steepening trend we are seeing in government bond markets.

While US economic data has been more mixed, with the recent US labour market report surprising to the upside, euro area data has continued to come in on the softer side. Euro area survey indicators have weakened further over the last month, while labour market indicators also now suggest that the euro area unemployment rate is set to drift higher from its current historic lows of 6.4%. Germany, in particular, is teetering on the brink of recession for what would be the second consecutive year. Meanwhile, wage growth is slowing in the region and headline euro area CPI inflation is drifting back to the ECB’s target, currently at 2.2% y/y. The latest core CPI inflation data is also now supporting this broad disinflation narrative. Therefore, unsurprisingly, recent ECB speakers have recognised the weakness in inflation and hinted at the possibility of an October rate cut. With that guidance, the market is now almost fully pricing a potential October rate cut. A continuation of the cutting cycle looks very likely in December, despite the data dependency of the ECB.

Fundamentally, we think this pick-up in the speed of rate cuts is justified as the mix of sub-trend Euro growth and at-target inflation argues for a much less restrictive monetary policy than is currently the case.

There are some hopes that recent Chinese policy support will help trade-sensitive markets like Germany, but we doubt this will be enough to offset the weak domestic demand picture within the region. There is also a risk that after the upcoming US elections in November, trade conflicts may return to the policy agenda – not just between the US and China, but also with the EU – presenting further downside growth risks.

The ECB deposit rate is currently being priced to reach around 2.50% by spring 2025.

Any further increase in oil prices, which have spiked higher due to escalating tensions in the Middle East, could complicate that picture somewhat on the inflation side, but we continue to hold some inflation protection to balance portfolios against these risks. In addition, we continue to like yield curve steepening trades and with the recent set back in yields, duration and fixed income in general.

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