Investors Gear Up for the ECB's Rate Cut in October

Investors are increasingly confident that the European Central Bank (ECB) will cut interest rates by another 25 basis points on October 17. This belief is driven by mounting evidence of a significant slowdown in both inflation and economic activity across the eurozone.

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In addition to the anticipated October rate cut, many analysts are now predicting a faster pace of reductions compared to previous forecasts, which had envisioned rate cuts happening once per quarter. This accelerated timeline is likely to result in lower yields on eurozone government bonds and a decline in the value of the euro.

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"Anything other than an October cut will now be difficult to justify," said Jussi Hiljanen, chief strategist for euro and dollar rates at SEB Research. His statement reflects the growing consensus that economic conditions warrant further monetary easing by the ECB.

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This shift in expectations was further fueled by a statement from ECB President Christine Lagarde. Speaking to the European Parliament on Monday, Lagarde expressed increased confidence that inflation would return to the central bank's 2% target. She indicated that this outlook would be a key consideration during the ECB's upcoming October meeting.

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Adding to the momentum for a rate cut, preliminary inflation data released on Tuesday showed that annual inflation for September had fallen to 1.8%, down from 2.2% in August. This figure is below the ECB's target, reinforcing the argument for further easing. "The time for gradualism is over: today’s eurozone inflation release paves the way for another ECB rate cut this month," wrote Natasha May, a global market analyst at J.P. Morgan Asset Management, in a note.

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According to data from LSEG Refinitiv, eurozone money markets are currently pricing in a total of 51 basis points in ECB rate cuts for the remaining two meetings of 2024. This includes the expected 25-basis-point cut in October. These expectations suggest that the ECB is moving away from its previous policy of data dependency for future rate decisions, according to SEB’s Hiljanen.

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SEB forecasts that the ECB will continue cutting interest rates at every meeting, with the deposit rate expected to drop to 2% by June 2025. This would mark a significant decline from the current rate of 3.5%. Similarly, Morgan Stanley expects the ECB to implement back-to-back 25-basis-point cuts from October until March 2025. After that, they predict a more gradual quarterly reduction, which would bring the deposit rate down to 1.75% by the end of 2025.

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As a result of these anticipated cuts, the yield on 10-year German government bonds, known as Bunds, is expected to decrease. Morgan Stanley analysts believe that the yield will soon fall toward 2% from its current level of 2.05%. By the end of the year, the yield could drop even further to around 1.8% to 1.9%. Looking ahead, the analysts forecast that the Bund yield could dip below 2% in 2025, with a potential consolidation around 1.6% by the first quarter of that year.

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In addition to the impact on bond yields, the euro is also expected to weaken as a result of the anticipated rate cuts. Michael Brown, a research strategist at Pepperstone, predicts that an accelerated pace of rate cuts will cause the euro to lose value, particularly against currencies like the British pound, the Australian dollar, and the Norwegian krone. This is because central banks in those regions are likely to adopt a slower and more gradual approach to cutting rates compared to the ECB.

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Lagarde’s recent comments stand in contrast to the approach taken by U.S. Federal Reserve Chair Jerome Powell. Speaking on Monday, Powell emphasized that the Fed was in no rush to cut interest rates again, following its substantial 50-basis-point reduction last month. This divergence in policy between the ECB and the Fed is likely to influence the relative strength of the euro versus the U.S. dollar.

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Monex Europe forex analysts highlighted this in a note, stating, "As we see it, Lagarde gave the clearest steer yet towards the idea that the ECB is about to step up their easing cadence, suggesting that inflation pressures were easing faster than had been expected." This indicates that the euro may face further downward pressure against the dollar in the near future as the ECB moves more aggressively toward rate cuts.

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In summary, the expectation of an imminent rate cut by the ECB in October, followed by further reductions in the coming months, is growing among investors and analysts. This outlook is driven by slowing inflation and economic activity in the eurozone, as well as recent comments from ECB President Christine Lagarde. The anticipated rate cuts are expected to lower government bond yields and weaken the euro, particularly against currencies from regions with less aggressive monetary easing policies. Additionally, the ECB's more aggressive stance contrasts with the U.S. Federal Reserve's more cautious approach, which could have implications for the euro-dollar exchange rate going forward.

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