ECB prepares for swift rate cuts as inflation nears target

Euro zone inflation could ease more quickly than previously thought and economic growth is also likely to remain weak, according to ECB policymakers and fresh surveys, reinforcing the case for a rapid pace of interest rate cuts in the months ahead.

The ECB lowered interest rates for the third time this year on Thursday on moderating price pressures. Investors now see rate cuts at each of the central bank’s next four or five meetings as inflation is within striking distance of its 2 per cent target and the bloc flirts with recession.

Sources close to the ECB’s deliberations said that inflation could ease to 2 per cent a few quarters sooner than earlier thought. This prompted some rate setters to make the case on Thursday for dropping a pledge to keep policy tight, the sources said, an implicit signal that more rate cuts are coming.

Speaking in blog post on Friday, Estonian central bank Governor Madis Müller also argued that the outlook had changed markedly in since the ECB’s last projections in September.

“Economic growth will be more modest than could have been expected just a month or two ago, and this will probably also reduce the pressure for price increases,” Müller said.

This view was reinforced by the ECB’s own Survey of Professional Forecasters, which showed inflation getting back to 2 per cent much more quickly than ECB staff now expect.

It predicted price growth at 1.9 per cent next year, below the 2 per cent predicted three months ago and well below the 2.3 per cent the ECB had pencilled for the year as a whole.

The ECB only sees inflation at 2 per cent in the final quarter of 2025 but the survey suggests this could happen much quicker especially since underlying price growth will also slow.

Many economists have revised their own forecasts since inflation eased to 1.7 per cent last month, its lowest rate in over 3 years and weak energy prices along with anaemic growth foreshadow muted price pressures ahead.

“We see inflation heading back up to 1.9 per cent in October and crossing 2 per cent again in December,” HSBC said in a note. “It should then hover between 1.6 per cent and 1.8 per cent for most of first half of 2025.”

‘CLEAR DIRECTION’ ON RATES

Part of the reason why policymakers and financial investors see rapid rate cuts is that economic growth continues to falter.

Indeed, a separate ECB survey of leading firms recorded a further slowdown in business momentum, even if they still saw some modest growth ahead as the expansion in services offsets a manufacturing recession.

The souring mood among the 95 large non-financial firms surveyed reflected growing concerns about competitiveness, uncertainty about the green transition, high costs and worries over political developments.

“This was causing businesses to scale back investment and focus on cost cutting, which also weighed on consumer confidence,” the ECB said, based on a survey of 95 large firms in late September.

All this adds up to a further moderation in price growth, the firms said, possibly bolstering the case for the ECB to cut interest rates quickly.

The ECB has spent the past three years fighting the worst bout of inflation in over a generation but some policymakers now think there is a realistic risk the bank could return to undershooting its 2 per cent target.

“The (policy) direction is to my eyes clear – we should continue to cut our restrictive monetary policy in an appropriate way,” French central bank chief Francois Villeroy de Galhau said on Friday. “But the pace must be guided by agile pragmatism.”