ECB preview: Acknowledging downside weakness means a rate cut

• At next week's ECB meeting on 17 October we expect the ECB to deliver yet another rate cut of 25bp, bringing the deposit rate to 3.25%. Weaker-than-anticipated growth indicators, as well as a decline in inflation, support the case for another rate cut from the ECB.

• Since the US labour market report last week, markets have significantly repriced expectations for policy easing across central banks, not least the ECB. Markets are now discounting an additional 47bp of rate cuts this year, consistent with a rate cut next week and again in December, and 97bp of rate cuts next year, consistent with our baseline of quarterly rate cuts of 25bp each.

• We expect very limited forward guidance at the upcoming meeting, meaning the ECB should stick to the 'meeting by meeting' and 'data dependent' approach that it has been following in the past few quarters. Ahead of the December meeting, where it will give new staff projections, including the 2027 projection, we are set to see very important data points from the euro area (2x PMIs, 2x inflation, wage data, labour data). 

Weaker growth and moderating labour market

Since the latest ECB meeting five weeks ago on 12 September, the ECB has received only a very limited amount of new data. However, this data has showed convincing signs of weaker growth and moderating labour market dynamics in Q3, that may extent into the current and coming quarters. Since the September meeting, the composite PMI indicator fell to 49.6 from 51.0 in August. The decline was largely driven by services moving lower from 52.9 to 51.4, where a part of the move can be explained by the one-off boost to French activity from the Olympic games disappearing in September. Overall, the service sector remains in expansionary territory, but it has weakened during the past quarter due to Germany and France while Spain is experiencing higher activity. For details, see Research euro area - Southern Europe to continue outperforming , 23 September.

Outside services, the manufacturing sector continues to struggle, with, for example, PMIs declining from 45.8 to 45.0. Given the long period with declining production, the employment situation has also clearly deteriorated, with the employment PMI at 46.1. The weak employment situation in the manufacturing sector has impacted the aggregate euro area labour market, where survey data into Q3 shows cooling employment growth in the euro area. Please see Research euro area - Moderating labour market with downside risks, 3 October. The moderating labour market and weakening growth support our expectations for a cut by the ECB in October. 

Combined with softer inflation supports October cut

Headline inflation fell below 2% for the first time in three years to 1.8% y/y in September, as expected. The decline was mainly due to energy inflation while core inflation was stickier at 2.7% y/y (prior: 2.8%) due to high services inflation at 4.0% y/y and low goods inflation at 0.4% y/y. Importantly, momentum in services inflation declined significantly as service prices rose only 0.1% m/m s.a., which was the lowest monthly rate this year. Headline inflation has averaged 2.17% in Q3, below the expectation of 2.3% in the latest ECB projections. Combined with the weakening of the services momentum, this should make the ECB more confident of inflation returning persistently to target.

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