Will the European Central Bank cut interest rates this week as expected?

The European Central Bank (ECB) is widely anticipated to cut its key interest rates at the September 12 meeting, marking its second reduction this year following a move in June.

The primary drivers behind this expected decision are weakening inflationary pressures and sluggish economic growth across the eurozone.

Eurozone annual inflation fell to 2.2% in August 2024, its lowest level since July 2021. Core inflation, excluding volatile components like energy and food, slightly decreased from 2.9% to 2.8%. However, services-related price pressures remained persistently high at 4.2%.

“With the latest inflation data out of the eurozone, a rate cut at the European Central Bank meeting has almost become a done deal,” Carsten Brzeski, global head of macroeconomics at ING said in an email note.

While inflation is cooling, growth indicators are equally concerning.

The eurozone’s gross domestic product grew by just 0.2% in the second quarter of 2024, a downward revision from the earlier estimate of 0.3%. Across the bloc, performance varied significantly, with Germany, the region’s largest economy, contracting by 0.1%.

“The ECB has enough reasons to further reduce the level of monetary policy restrictiveness,” Brzeski added.

Investors focused on ECB’s updated projections

At this meeting, investors will also scrutinise the ECB’s updated macroeconomic projections.

Back in June, the ECB raised its forecasts for both growth and inflation in 2024, compared to the previous estimates.

At that time, annual economic growth for the eurozone was projected at 0.9% in 2024, with a further strengthening to 1.4% in 2025 and 1.6% in 2026.

Inflation, meanwhile, was expected to decline from 5.4% in 2023 to 2.5% in 2024, 2.2% in 2025, and 1.9% in 2026.

According to Brzeski, the ECB’s new forecasts are likely to show largely unchanged growth estimates, but a slight downward revision to inflation for 2025 and 2026, supported by lower oil prices and a stronger euro.

ECB to adjust its key policy rates

A notable feature of the September meeting will be the new adjustment to the ECB’s various key rates.

Analysts expect the deposit facility rate to be cut by 25 basis points, while the main refinancing rate and the marginal lending facility rate may be reduced by 35 basis points.

Currently, these rates stand at 50 basis points and 75 basis points above the deposit facility rate, respectively.

What comes next after September?

Looking beyond this meeting, the ECB is likely to reaffirm its “data-dependent and meeting-by-meeting” approach, according to Sven Jari Stehn, an economist at Goldman Sachs.

“They are expected to justify the rate cut by expressing confidence in the disinflation process, while making limited changes in their communication.”

Goldman Sachs expects a pause in October, followed by a third rate cut in December. The pause is based on the assumption that limited new data will emerge by October to alter the ECB’s narrative.

However, Stehn acknowledged that an October rate cut could still be on the table if the eurozone experiences significant economic surprises.

Looking further ahead to 2025, Stehn foresees a more aggressive pace of cuts due to a weakening activity outlook and slower wage growth, which should help services inflation normalise. “We now forecast sequential 25 basis point cuts in 2025, bringing the deposit rate down to 2% by July.”

Ruben Segura-Cayuela, an economist at Bank of America, also expects a 25 basis point cut at next week’s meeting.

He anticipates that the ECB will maintain its current guidance, reiterating its data-dependence and gradual approach to policy changes.

Bank of America also expects another 25 basis point cut in December and predicts a total reduction of 125 basis points throughout 2025.

“Data should eventually push the ECB to speed up the cutting cycle, with one cut per meeting from March 2025 onwards,” Segura-Cayuela noted, predicting the deposit rate could reach 2% by the second half of 2025.