ECB Review: dovish though unnecessarily complicated

As expected, the ECB Governing Council (GC) decided to lower the three key interest rates by 25 basis points (bps), bringing the depo rate to 3%. This is the 4th rate cut, and third back-to-back, totalling 100bps of monetary policy normalisation since last June. Also, unsurprisingly, Ms Lagarde reiterated several times that upcoming decisions will remain on a "meeting by meeting approach" and "data dependant". Meanwhile, quantitative tightening is to continue happening in the background with the Pandemic Emergency Purchase Programme's (PEPP) partial reinvestment (€7.5 billion per month since last June) to end by the close of 2024 and the last repayment of the third set of Targeted longer-term refinancing operations (TLTRO III). We do not expect these to have any meaningful market impact, with excess liquidity in the Eurosystem still projected to be higher than pre-covid throughout our forecast horizon. Hence, there is no contradicting message as the ECB reaffirms in its policy statement that "the deposit facility rate – the rate through which the Governing Council steers the monetary policy stance".

While we expected a simple amendment, the ECB GC decided on a full removal of the forward guidance, generating unnecessary uncertainty in our view. The monetary policy statement dropped the sentence "it will keep policy rates sufficiently restrictive for as long as necessary to achieve this aim". Though it kept the reference that rates are restrictive at current levels (3%), this change generated the most questions during the Q&A, rightly so. President Lagarde responses have been unclear, lacking conclusiveness, likely reflecting the diverging views as to where the neutral rate is among GC members. The market initially took the drop of the mention as a dovish sign, we are not sure that it is such a clear cut. Towards the very end of the press conference, she eventually mentioned that conventional wisdom would see nominal neutral rate between 1.75% and 2.5%. This means there is still some distance to it and providing ECB revised outlook is confirmed - and with it increased confidence of inflation landing sustainably at 2% - the ECB GC is likely to cut again at least by 25bps at the next two meetings at least. Finally, she mentioned an upcoming speech, next Sunday, where she will discuss at length about restrictiveness where we may get more analytics and clearer conclusions. 

The ECB also released its macroeconomic projections which extended its forecast horizon to 2027. Near term growth is unchanged with +0.2% quarter-on-quarter (qoq) projected in Q4 but quarterly pace for 2025 has been lowered to +0.3% from +0.4% (starting in Q2 2025) (1.1% on annual average from +1.3%, slightly above our forecast at 1%). We agree with the ECB's explicit mention of downside risks, particularly from the slower normalization of saving rate (the ECB foresees a decline from a peak in Q4 2024 which is a strong assumption given the current domestic and external outlook for policy and politics).

On inflation, changes are marginally skewed to the downside with near term volatile components being lower. Core inflation is unchanged at 2.9% in 2024 (which implies a bump expected in December at 2.8% year-on-year - yoy - minimum) and 2.3% in 2025. However, 2026 and 2027 quarterly projections give an interesting signal with core inflation being stable at 1.9%, slightly below target. On top of that, Ms Lagarde insisted few time that inflation risk was "two sided", opposing previous meetings in which she used to emphasize more upside risks.

Overall, today's press conference confirms our call of back-to-back 25bps rate cuts at every meeting until June (2%). Going into 2025, we continue to believe the ECB will see more downside risks materialising to its inflation outlook (particularly for 2026) via the growth channel and raise the risk that the ECB will have to go into accommodative territory (below [1.75%-2.5%] as mentioned by MS Lagarde), consistent with our call of a terminal rate at 1.5% by year end 2025 at the latest. In terms of risks, we have not sensed any eagerness in the ECB's mood to move faster, but we reiterate that the risks are on the downside and that the ECB could therefore decide to be more aggressive with a 50bps rate cut at some point.

Hugo Le DamanyFrançois Cabau