ECB preview: The ECB’s rate cut cycle…it’s probably over
The Governing Council kept policy on hold in July, and is likely to remain on hold at the September meeting and for the foreseeable future.
ECB policy rates
President Lagarde has said that the ECB is ‘well positioned’ to face the coming period of tariff impact and uncertainty. Despite the expected undershoot of the 2% inflation target, the GC seems minded to look through this on the expectation that inflation will return to target in 2027. Although the ECB’s inflation projections in June factored in one more 25bp rate cut (based on market rate expectations at the time), we doubt the Governing Council is minded to fine-tune policy to that degree. Even if the period of disinflation proves more prolonged that it currently expects, it will probably continue see inflation back to target over the medium term. The exception is if there were to be a significant growth shock, which sees the economy weakening for a more significant period than the ECB currently expects.
Projections
The ECB will publish updated projections for the macroeconomic outlook alongside the decision. The new forecasts will unlikely change much compared to the June vintage. There have been headwinds for the growth outlook (somewhat higher oil prices, a firmer euro and higher tariffs than previously assumed), though we expect the ECB to ramp up its assumptions for Germany’s fiscal stimulus, while recent data has been stronger than expected. Similarly, the projections for inflation are unlikely to change much, not least because the ECB has returned to its agnostic view of the impact of tariffs on inflation.
TPI and the bond market
Recent weeks have seen continued escalation of bond market worries about public finances as well as the outlook for bond supply. Political instability in France has also added some fuel to this move. ECB President Lagarde will most likely be asked by journalists whether this causing concern at the central bank and under what conditions it would employ its tools to calm markets down. In our view, market moves to date are not even close to levels that would trigger any kind of response from the ECB, either in terms of outright yields generally, or for instance France’s spread over Germany. Yields would need to rise much more sharply to generate concerns about either tighter financial conditions (which could be offset by rate cuts) or market stability (where liquidity measures or asset purchases could come into play). When it comes to spreads, the TPI is its main tool. France would not be eligible given it is in excessive deficit, but the ECB could use it to prevent contagion to countries whose fiscal fundamentals are healthier.