BlackRock: ECB is dancing the waltz rather than a quick step

September 12, 2024

Interest Rates ECB

By Ann-Katrin Petersen, investment strategist at the BlackRock Investment Institute

Bottom line: The ECB cut rates by 25 basis points today, as expected, having revised down its growth projections but still expecting inflation to fall to its 2% target in the second half of 2025. We think the ECB could cut again this year as rates are still highly restrictive. But we think market speculation of another cut next month is optimistic.

Sticky inflation means only a further sharp economic deterioration would prompt the ECB to speed up from quarterly, quarter-point cuts, in our view. We prefer income in short-dated euro area bonds over short-dated US Treasuries.

A second cut, but more a waltz than a quick step

As expected, the ECB cut rates by 25 basis points today, supported by fresh macro projections (lower growth, broadly stable inflation outlook). It’s the ECB’s second cut after initiating the easing cycle in June. President Lagarde reiterated that the ECB would follow a “data-dependent, meeting-by-meeting approach”, and did not rule out an October cut. We think the ECB will stick to a quarterly pace of cuts this year – dancing the waltz rather than a quick step. For now, only a further sharp economic deterioration would prompt the ECB to speed up with back-to-back or larger cuts, we think. And we will only have a little more data in October and a lot more in December. We think the ECB will prefer to proceed slowly, at least until it can confirm its assumed return of inflation to its 2% target in the second half of 2025 and wage growth moderates further.

Sticky inflation means policy will stay tight

Like the hiking cycle, this is not your typical cutting cycle: This is not a return to the world we once knew, where inflation was consistently well below the 2% target. With labour markets still tight and productivity weak, domestic price pressures could keep inflation near or above 2%, even if we think wage growth will cool further from current (still too high) levels. Given the ECB raised rates to highly restrictive levels, a steady pace of rate cuts over coming quarters would still leave policy weighing on growth. That’s even after accounting for what is likely now a higher neutral policy rate due to structural shifts.

No big surprise for markets

After today’s ECB meeting, markets still see a reasonable chance of an October cut. Investors should keep the big picture in mind: rates will likely stay structurally higher than before the pandemic, supporting the appeal of income. On a tactical horizon, we now prefer income in short-dated euro area bonds and credit over short-dated US Treasuries. We think market expectations of Fed rate cuts have gone too far. We remain tactically neutral long-term euro area government bonds as we think yields will keep swinging in both directions on new economic data. We continue to favour U.S. stocks over Europe’s on stronger corporate earnings and the AI theme.