ECB Cuts Rates, Markets Erupt!

The European Central Bank's (ECB) interest rate cut has finally been implemented, but the market was not surprised.

Rumors that the ECB would cut interest rates in September have been brewing for a long time.

After announcing a 25 basis point cut to 3.75% in June, the ECB unanimously voted to keep interest rates unchanged in July.

At that time, the ECB stated that the possibility of a rate cut in September was "very high."

Financial institutions including JPMorgan Chase, Morgan Stanley, Bank of America, and Berenberg Bank also bet on the ECB's rate cut news.

On the evening of September 12th Beijing time, the suspense was revealed.

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The ECB announced its interest rate decision, cutting the deposit facility rate by 25 basis points and lowering the main refinancing and marginal lending rates by 60 basis points.

After this rate cut, the main refinancing rate, marginal lending rate, and deposit facility rate are 3.65%, 3.90%, and 3.50%, respectively.

After the news was announced, the euro's exchange rate against the US dollar rose, and the real-time exchange rate instantly rose to 1.1022.

As of the time of writing, the current exchange rate is stable around 1.103.

In terms of commodity prices at the time of the ECB's interest rate decision announcement, London gold once rose to a record high of $2,551.69 per ounce; the gold price on the New York Commodity Exchange COMEX also rose to a record high of $2,572.3 per ounce.

As of the time of writing, major European stock indices have basically maintained an upward trend.

ECB President Christine Lagarde said at the subsequent monetary policy press conference that the decision to cut interest rates by 25 basis points was unanimously agreed upon, and they will continue to ensure that inflation returns to the 2% medium-term target in a timely manner.

The interest rate cut was no surprise, as Berenberg Bank's Chief Economist Holger Schmieding said in an email to clients, "The interest rate cut should be essentially uncontroversial."

Before this, almost all ECB spokespersons had stated their position on the interest rate cut in recent statements.

Even Joachim Nagel, the head of the German central bank, who is usually considered a hawkish representative of the ECB Council, also said that unless there is evidence against it, he will support the rate cut.

A report released by Bank of America analyst Ruben Segura-Cayuela and his team also showed that BofA believes the ECB will cut interest rates by 25 basis points and may be accompanied by a dovish tone that will quickly and continuously cut interest rates.

Due to the widespread expectation of a rate cut, European stocks continued to rise after the data was released, and the euro rose slightly.

For most market participants, the biggest issue is not whether the ECB will cut interest rates on Thursday, but what kind of guidance the ECB can provide for future interest rate changes, and how the economic outlook will develop.

Berenberg Bank economists predict that the European Central Bank will pause interest rate hikes at the policymaker meeting on October 17th, just like in July, and then cut interest rates by another 25 basis points on December 12th.

Economists at consulting firm Pantheon Macroeconomics believe that the September rate cut may be the last rate cut of the year.

"Our forecast for a significant rebound in core inflation in the fourth quarter has led us to cancel the expectation of a rate cut in December.

If the ECB, as widely expected by the market, does not move in October, then this rate cut may become the last rate cut of the year," Pantheon Macroeconomics wrote in the report.

The ECB did not confirm the market's prediction of the interest rate cut path.

Lagarde said at the press conference, "Interest rate decisions will be based on our assessment of the inflation outlook based on upcoming economic and financial data, underlying inflation dynamics, and the strength of monetary policy transmission," and reiterated that they will continue to follow a data-dependent and meeting-by-meeting approach, "We will not pre-commit to a specific interest rate path."

The ECB's key interest rates will provide a basis for pricing various loans and mortgages in the eurozone, and once borrowing costs approach 3%, policy-making will become more difficult.

Therefore, "officials must be more cautious when approaching the so-called neutral interest rate to avoid hindering the return of inflation to 2%," said Isabel Schnabel, a member of the ECB's Executive Board and a German economist.

In addition to lowering interest rates, the European Central Bank also lowered its growth forecast for 2024 to 0.8%, slightly lower than the previously predicted 0.9%; it will rise to 1.3% in 2025 and 1.5% in 2026.

The reason given by Lagarde is: "Wages are still growing rapidly, inflation remains high, but labor cost pressures are easing, and profits to some extent cushion the impact of wage increases on inflation.

However, financing conditions are still limited, and economic activity remains sluggish, reflecting weak private consumption and investment."

Two major factors support the driving factors behind the interest rate cut, which are the lack of economic growth in the eurozone and the cooling of inflation.

James Rossiter, an analyst at TD Securities, pointed out when talking about the ECB's interest rate cut prospects, "Service sector inflation is at a 10-month high, unemployment is at a record low, and price pressures are clearly present... At the same time, economic growth is slowing down, and risks are clearly biased towards the downside."

Let's first look at inflation.

According to preliminary statistical data released by Eurostat on August 30th, the inflation rate of the 20 eurozone countries has dropped from a high of 10.6% in October 2022 to 2.2% in August, the lowest level since July 2021, close to the ECB's 2% target.

Joachim Nagel said in an interview with the German "Frankfurter Allgemeine Zeitung" in early September, "The big wave of inflation has ended," and "(inflation) will continue to decline not only in Germany but also throughout the eurozone."

However, this does not mean that the road ahead is "smooth sailing," and inflationary pressures are still evident in some industries, especially the service sector.

Specifically, in August, the service prices in the eurozone rose by 4.2% year-on-year, food and tobacco prices rose by 2.4%, non-energy industrial product prices rose by 0.4%, and energy prices fell by 3.0%.

In that month, the core inflation rate, excluding energy, food, and tobacco prices, was 2.8%.

Looking at the country, the inflation rates in the major European economies of Germany, France, Italy, and Spain in August were 2.0%, 2.2%, 1.3%, and 2.4%, respectively.

Recently, the former head of the European Central Bank, Jean-Claude Trichet, emphasized at the Sixth Bund Financial Summit that anchoring a 2% inflation expectation is crucial.

The core inflation rate in the eurozone in August remained at 2.8%, significantly higher than the 2% target.

"The problem faced by the European Central Bank is that the overall inflation rate in the eurozone in August has dropped to 2.2%, but the core inflation rate has not declined as quickly as expected," Trichet said.

Dennis Shen, an economist at the European rating agency Scope Ratings, pointed out that the fragility within the 20 eurozone countries "strengthens the rationale for adopting a more accommodative monetary policy," but "inflation has not yet been defeated," making the European Central Bank cautious.

On the other side of cooling inflation is a weak economy.

On September 6th, Eurostat data showed that the eurozone's GDP grew by 0.2% quarter-on-quarter in the second quarter, lower than the initial and expected 0.3%; year-on-year growth was 0.6%, in line with expectations.

In the first quarter, the eurozone's GDP grew by 0.3% quarter-on-quarter and 0.5% year-on-year.

Among them, the German economy shrank by 0.1%, mainly due to the drag from the manufacturing industry.

In addition, according to data released by S&P Global and the Hamburg Commercial Bank (HCOB), Germany's manufacturing PMI in August was 42.1, lower than the expected 43.3; the service sector PMI was 51.4, also lower than the expected 52.3.

Germany is the largest economy in the region, and the sluggishness of the German economy has become a key factor in the eurozone's economic weakness.

Industry insiders pointed out that weaker economic indicators may pose a risk to the eurozone's economic growth prospects.

At the same time, the still sluggish investment indicates that companies expect the economy not to recover strongly.

Lagarde also admitted at the press conference, "The economic recovery is facing some resistance," and the risks are still biased towards the downside.