ECB cuts, attention turns to the Fed

The ECB cut the deposit by 25bps to 3.5% at yesterday’s meeting, as expected, but gave nothing away regarding the pace and timing of future moves. The market has pared back expectations for rate cuts a little post meeting, but still expects at least one more 25bps reduction this year, is pricing in about a 40% chance of a second, and sees the deposit rate falling to around 2% by this time next year. The euro has advanced against the dollar, strengthening to around $1.1080, as has sterling, to around $1.3140 – suggesting the market may be quickly turning its attention to next week’s Fed meeting – leaving EURGBP marginally lower at around £0.8430.

Government bond yields nudged higher yesterday but that is being reversed this morning, led by a decline in US yields in another indication that the market focus is turning to the Fed  meeting (with a former Fed member, Dudley, saying there is a “strong case” for a 50bps rate cut next week). Equity markets had another positive session yesterday, with both European and US stocks gaining around 1%.

The ECB’s latest forecasts again show inflation returning to 2% over the second half of 2025, which was the cue for it to lower interest rate for a second time yesterday. It expects core inflation to be higher in the short-term than previously projected, owing to sticky services inflation, but to decline rapidly during 2025. It also lowered its growth forecasts slightly, but still sees the pace of activity picking up over the next couple of years. In terms of its policy stance, the ECB reiterated that it will keep rates “sufficiently restrictive for as long as necessary to ensure inflation returns sustainably to the 2% target, which suggests to us that the next but one meeting in December is the most likely date for a third cut in the cycle.

In comments earlier this morning, ECB member Villeroy said the central bank “should continue to reduce gradually and as appropriate the degree of restriction of our monetary policy,” adding that “we must be attentive to the risk of undershooting our (inflation) target as much as to the risk of overshooting it.”

Economic data due today include Euro area industrial production – which has been particularly weak recently, falling in each of the three months to June – as well as import prices and the University of Michigan survey of consumer confidence/inflation expectations in the US.