Vanguard: Faster pace of ECB interest rate cuts in 2025
Shaan Raithatha, Economist at Vanguard, looks ahead to the ECB meeting later this week:
'The ECB will likely deliver its fourth interest rate cut of this cycle at its December meeting. Expect a dovish tilt in language given recent soft activity data, rising risks to global trade, and increased political uncertainty in France and Germany. We maintain our call that the ECB deposit facility rate will be lowered to 1.75% by the middle of next year.
The ECB will probably nudge lower both its inflation and growth forecasts at the December meeting, relative to the projections published in September. Both headline and core CPI have come in slightly lower than expected in recent months, though services inflation remains elevated. The strength of the latter has been partly driven by transport services base effects.
On the growth side, high-frequency indicators have deteriorated a little too. Much attention has been given to the sharp drop in the November PMIs. But other indicators, including the European Commission’s Economic Sentiment Indicator, the German IFO, and German factory orders, suggests the current weakness is less dramatic than initially feared.
That said, the outlook for 2025 has darkened. First, higher tariffs will be mildly negative for growth. In our base case, we expect a hike on tariffs for European autos to 25% and an increase in broader-based tariffs to 5%. Together, after accounting for the prospect of retaliation, front-loading, a re-routing of trade, and a weakening euro, we expect 2025 growth to be 0.2 percentage points lower relative to our September forecast.
Second, political uncertainty has intensified given the collapse of both the French and German governments. Higher uncertainty will naturally weigh on business and consumer confidence and limit growth, especially if the situations persist. That said, we are encouraged by the behaviour of French government bond spreads, which have remained range bound since the initial spike triggered by the summer election.
Overall, we expect the Governing Council to vote for a 25bp cut on Thursday, which will leave the deposit facility rate at 3%. We also expect the statement to lean dovish, reflecting the softening growth outlook and the increasing chance of an inflation undershoot. One example could be the dropping of the reference to policy being “sufficiently restrictive for as long as necessary”. We continue to expect the pace of rate cuts will quicken in early 2025 and for the policy rate to fall to 1.75% by the middle of the year, a notch below neutral.'