ECB Preview: dovish enough?

• We expect the European Central Bank (ECB) to decide on another 25 basis points (bps) deposit facility rate (depo rate) cut to 3.0% at its 12th December meeting, as widely expected.

• We envisage some dovish change to the forward guidance, but the Governing Council (GC) is likely to keep full flexibility with meeting-by-meeting, data-dependence decision making.

• We expect the ECB to make downward revision to both its growth and inflation outlook with risks still skewed to the downside.

• Rates market has heavily repriced since last meeting. Risk seems skewed for the ECB to under deliver on expected dovish bias.• We expect back-to-back rate cuts to 2.0% next June, reaching 1.5% by year-end. Risks are skewed to the downside. 

A 25bps rate cut as widely expected. We look for the ECB Governing Council (GC) to cut the depo rate by 25bps to 3.0% reducing it, cumulatively, by 100bps since last June. While the flow of recent activity (November Purchasing Managers' Indexes - PMIs) and inflation (flash for November) data could have justified a larger move - the market has priced a 50bps rate cut at more than 30% probability in the past week - we expect this third back-to-back 25bps rate cut to receive at least a large majority within the GC, reflecting a gradual approach put forward by both hawkish (e.g. Schnabel, Holzman) and dovish (e.g. Lane, Stournaras) Governing Council members. Unequivocal comments by President Lagarde at her hearing at the European Parliament this week has definitely brought down the probability of 50bps move (below 10%).

Retaining full optionality (for larger cuts). Unchanged from previous meetings, we think ECB’s communication will keep full optionality on its meeting-by-meeting approach and data-dependence, as recently argued by Philip Lane, Villeroy de Galhau and President Lagarde, de facto keeping open the option for larger cuts at a later stage. We think the moment is not right for a larger move in December (or in January for that matter). Firstly, the November PMIs drop looks oversized and more sentiment-based than on actual flow of business. In the same vein, Q4 24 GDP data will be distorted (to the downside) by the payback from the Olympics in France (AXA IM: 0.0% quarter-on-quarter - q/q - after 0.4% q/q in Q3), and Spanish floods (AXA IM: 0.6% q/q after 0.8% q/q in Q3). Q3 24 negotiated wage growth peaked up to 5.4% year on year (y/y), while headline inflation is inching up above target towards the end of the year. Similarly to other official institutions, the ECB cannot take into account future measures by the Trump administration in their forecasts until they are passed by Congress, and can only cite heightened uncertainty in their outlook, as Lagarde recently did. Finally, the ECB would not want to be perceived as coming to the rescue of French political budget issues generating upside pressure on French yields (more on this below).

Possible (dovish) change in forward guidance. Willing to keep full policy flexibility while having gone half of the way towards neutral (2%), and likely downwardly revised growth and inflation forecast could nonetheless imply slight changes to the guidance going forwards. The following sentence “It will keep policy rates sufficiently restrictive for as long as necessary to achieve this aim” could be altered to a softer, more forward looking bias with “a gradual removal of restrictiveness provided data confirm [ECB’s] outlook”, echoing most recent dovish turn by Lane, Villeroy de Galhau and Lagarde.

It cannot hurt to mention Transmission Protection instrument (TPI) is here. Given the recent rise in OAT-Bund - bonds issued by the French treasury - spreads (to c.80bps from c.70bps at the time of the previous meeting), journalists are likely to ask President Lagarde whether the ECB could do anything to reduce market pressure. We do not think that action is required to “counter unwarranted, disorderly market dynamics that pose a serious threat to the transmission of monetary policy across the euro area”. The rates market will continue to function along the curve and there will be no contagion to other sovereigns that might impede monetary policy transmission. OAT-Bund movements mainly reflect political uncertainty that can be reversed without the implementation of a backstop. That being said, it may not hurt for President Lagarde to restate that the ECB has this tool at its disposal should it be required.

Expected downward revisions from fresh ECB forecasts. We think Eurosystem staff are likely to revise downwardly revise the ECB’s growth baseline by 0.1 percentage points (pp) this year to 0.8%, in line with our own, and by 0.2pp (to 1.1%, AXA IM: 1.0%) next year, owing to short-term disruptions (French Olympics, and Spanish flood affecting Q4, and thus the carry over for 2025), but also to new headwinds such political uncertainty, notably in France and Germany, as well as the policy uncertainty coming from the US and China. This would also affect 2026 growth (-0.1pp to 1.4%). In this context, it will be key to monitor the revised savings rate assumptions. We think these factors are likely to offset a c.35bps rally in short-end curve since the previous forecast cut-off. Finally, fresh 2027 vintage is likely to look on the strong side (1.5%-1.6%), looking to reabsorb the negative output gap created in previous years.

Lower inflation starting point to be carried through. Eurosystem staff are likely to revise inflation forecasts down due to the missed drop in September. Indeed, core inflation came lower than expected and this should translate into a 0.2pp difference in Q4 2024 at around 2.7% y/y. Looking forward, we do not anticipate any material changes but the lower starting point to be carried through and core inflation could cross 2% in H2 2025 instead of H2 2026 as projected last September. One factor that could dampen the deceleration is that the Euro (EUR) depreciated 4.5% against the US Dollar (USD) since September and 2% from a nominal effective exchange rate (NEER). If it persists over time, it could translate into a small bump for headline inflation by around +0.1/0.2pp but is likely to be seen in H2 2025 at best when inflation will already be at or slightly below target. Besides, this slight upside may be offset by the lower growth profile. Overall, the revised ECB’s forecast will likely remain above ours owing to their growth profile. Core inflation should average 2.1-2.2% (from 2.3%) in 2025 and be at 2% (unchanged) in 2026. Likewise, fresh vintage of 2027 headline inflation should be at 2.0%.

Watch out for a (dovish) under delivery. On recent data, ECB forecasts are likely to be revised down. The ECB's latest comments confirm an expected dovish skew at the December meeting, which will, in our view, result in amended forward guidance. However, prior to the recent sell-off in the past few days, both the short (-20bps to 1.6% priced for December 2025) and long end (10y bund: -15bps) of the rate markets have rallied significantly since last meeting. The risk seems for under delivery of that dovish tone, thus resulting in a possible market sell-off.

Our baseline is for a gradual rate cutting path ending at 1.5% by end-2025, with downside risks. ​ We project euro area GDP to grow by 1.0% and 1.3% in 2025 and 2026 respectively, keeping our below-consensus views. Domestic and external downside risks to prevail. We expect modest domestic demand momentum consistent with slower core inflation, leading headline inflation to undershoot the ECB’s target, averaging 1.9 and 1.7% in 2025 and 2026 respectively. Following back-to-back 25bps rate cuts with the depo rate reaching 2.0% in June 2025, within the vicinity of neutral, we expect the ECB to move rates into an accommodative stance by cutting 25bps at forecast meetings to 1.5% by end-2025. Given the downside risks to our growth and inflation outlook, we think this could come sooner than end-2025, with the ECB forced into more accommodative territory.

Hugo Le DamanyFrançois Cabau