ECB About to Step Up the Pace it Cuts Rates: Deutsche Bank

Above: Christine Lagarde. Image by Dominique HOMMEL. © European Union 2019 - Source: EP

Deutsche Bank has shifted its baseline expectation for the ECB's monetary policy from a "gradual normalisation" to a "faster normalisation" scenario.

This change in thinking is driven by three primary factors:

Weak Economic Data: Recent economic indicators, including a weakening PMI and potential negative growth in Germany, France, and Italy, suggest that the ECB's constructive outlook on growth might be overly optimistic. The bank highlights the possibility of the ECB staff revising its GDP forecasts in December.

Inflation Expectations: While still above target, headline HICP is projected to fall below 2% from February 2025 onwards. Deutsche Bank anticipates the ECB will initially question the sustainability of sub-2% HICP, but as core, services, and labour cost inflation decline, confidence in a sustained return to target should solidify. This supports the case for faster easing.

ECB's Stance: The ECB has not actively countered the market's expectation of declining central bank rates. Deutsche Bank interprets this as a sign that the Governing Council acknowledges the emerging downside risks to both growth and inflation and views the market's easing expectations as a reasonable hedge against these risks.

Previously, Deutsche Bank expected the ECB to pursue a gradual approach, cutting rates by 25bp per quarter until reaching a neutral rate of 2.00-2.50% by the end of 2025.

This is in line with the market consensus and the consensus of economists following the ECB's September policy update.

However, under the "faster normalisation" scenario, they now predict the ECB will reach the same terminal rate by mid-2025, employing back-to-back 25bp cuts starting in December 2024.

Despite favouring the "faster normalisation" scenario, Deutsche Bank acknowledges several factors could alter the ECB’s policy path:

Labour Market Dynamics: The extent to which weak growth translates into higher unemployment and, consequently, weaker wage inflation remains crucial. Deutsche Bank acknowledges differing opinions within the ECB regarding the sensitivity of labour costs to economic conditions.

Margin Compression: While there are signs of margin compression in certain sectors, the recent widening of the PMI margin proxy introduces uncertainty. The persistence or reversal of this trend will influence the ECB’s assessment of inflationary pressures.

Global and Political Uncertainties: The outcome of the US election, potential trade wars, political fragmentation within Europe, and geopolitical instability all represent significant wildcards that could impact the ECB's policy decisions.

Deutsche Bank emphasises the ECB's data-dependent approach, suggesting the central bank will remain nimble and adjust its policy stance based on evolving economic conditions.

It does not rule out the possibility of a 50bp cut in December 2024 or a faster pace of easing if economic data deteriorates significantly.