Markets traded mostly sideways through the press conference as no guidance was given of how aggressive the cutting cycle will be or the potential end-point.

‘Well on track’

The ECB judged that since the last GC meeting in September ‘The incoming information on inflation shows that the disinflationary process is well on track.’ And that the ‘inflation outlook is also affected by recent downside surprises in indicators of economic activity’. This morning the final inflation release also confirmed the surprisingly low inflation momentum, driven by services, which supported the ECB’s assessment. During the press conference Lagarde said they were ‘all a little bit surprised by the acceleration’, with a reference to the inflation print of 1.7% y/y in September.

Downside risks gaining traction

Listening to Lagarde yesterday, it was clear that the weakening of ‘all indicators’ since the last meeting has come as a surprise for the governing council. This raises the question of whether the ECB should intensify its efforts towards policy easing. However, the ECB is still seeking clarity on whether the current tight financial conditions have adequately addressed the underlying drivers of inflation. The labour market continues to demonstrate resilience, although employment has recently plateaued, and domestic inflation remains high at nearly 4% (3.9% in September), propelled by sustained wage pressures. The ECB still observes signs of profit margins absorbing rising costs, which is crucial for the continuation of the disinflationary process. However, it remains concerned that the current resumption of household purchasing power might fuel future inflation. The substantial data package (e.g. 2 x PMI, 2 inflation prints) prior to the December meeting could become instrumental for the staff projections and to what degree the risk of undershooting the inflation target has risen recently. At yesterday’s meeting, Lagarde remained hesitant about making any clear judgements, but recall that just a month ago, ECB members seemed split on the need to cut rates at the October meeting. Yesterday, the decision was taken unanimously.

Still restrictive, but for how long?

The ECB’s decision also included an interesting reference to financing conditions remaining restrictive; however, with the weak economic activity and disinflationary process on track, the question becomes for how long should we expect the ECB policy stance to stay restrictive? In our baseline scenario, we see the ECB only cutting to 2%, which is broadly considered the neutral policy rate by the end of next year. However, the bigger question remains whether there is a risk of the ECB feeling the need to cut slightly below that. Markets are pricing this at around 40% .