ECB has shattered Traders’ Hope for an October Rate Cut
Written by Quorica Capital Global Markets Team – Anapekshya Kandel
European Central Bank current monetary policy
The ECB announced earlier this month that they have decided to cut their main refinancing rate (key interest rate) to 3.50%. The reasoning, as stated on the ECB’s website, being that inflation in the Eurozone has gradually decreased but still hasn’t hit the target of 2%. The European Union annual inflation was 2.4% in August 2024 and although it is close to the target rate, it is still above therefore, a slight restrictive policy has been put in place.
In addition, the ECB will maintain a difference of 0.15% between the main refinancing rate and the deposit facility rate, as announced in March 2024. Moreover, the difference between the marginal lending facility and the rate on the main refinancing operation will continue to be 0.25%. Therefore, the main refinancing operation rate decreased to 3.65% and the marginal lending facility rate decreased to 3.90%
This decision was dependent on several, one is inflation as already mentioned and the other is economic growth. As the economy isn’t growing as fast as the ECB expected, a reduction in interest rates will be implemented. This policy alongside the rising wages and lower inflation is expected to encourage an increase in consumer spending and investments which will help the economy grow.
Market Reaction
Before the announcement many traders have hoped for an October interest rate cut in as inflation fell to 2.2% in August which was a two-year low. However, many traders and even economists at Goldman Sachs are predicting that the cut will not occur due to the prediction that the economy will not significantly change and therefore, the ECB will see
no reason to make an October cut. Core inflation has remained high and due to the wage growth in Europe there is a possibility that, if not restricted, inflation may rise. Moreover, although the economy isn’t growing as fast as expected, the economic slowdown isn’t significant enough so the ECB may not want to risk an increase in inflation by decreasing interest rates.
Implications for Financial Markets and Broader Economic Context
The impact the ECB monetary policy may have been listed below.
Bond yields – When interest rates decrease, prices of existing bond increase due to an increase in demand. The increase in price will lead to the lower bond yield as shown by the bond yield formula (coupon payment/ price of the bond = yield).
Stock markets – A reduction in interest rate tends to promote consumer spending and investing this will then result in a higher demand for stocks which will then increase stock prices. However, due to the ECB interest cut being expected the European stocks hardly changed after the decision was announced.
Currency movements – A lower interest rate tends to a depreciation. The reduction in interest rates will lower the returns on investments on assets that are interest-bearing such as bond yields. The reduction in bond yields will deter investors and therefore will reduce the demand for currency. The reduction in demand will then cause depreciation. The euro has experienced a downwards trend this year, depreciating from being worth £0.87 on 21 September 2023 to £0.84 on 21 September 2024. It is likely that part of the reason was the decrease in interest rates however due to the minimal difference across the year it is unlikely that a significant change will occur.
Macroeconomic factors –
GDP – A lower interest rate will decrease the cost of borrowing which will therefore encourage more spending and investment occurring. The increase in spending and investments will then result in the economy growing. This theory has proven to be correct as in the second quarter of 2024, seasonally adjusted GDP increased by 0.3% in the euro area following an interest cut.
Inflation- Although the interest rate has decreased it still is quite high therefore, inflation should decrease. This reasoning is echoed by the ECB themselves who released their predicted projection of inflation to decrease from 2.5% in 2024 to 2.2% in 2025.
Conclusion
In conclusion, the ECB decided to cut interest rates in September so they can reach their goal of lowering inflation and encouraging economic growth. The decision will impact the financial market and the economy in several ways. However, due to inflation being persistently above the 2% target alongside wage growth which may cause inflation to grow it is unlikely in my opinion that an October rate cut will occur.