Is October the beginning of consecutive rate cuts? The European Central Bank faces five major issues

At the upcoming meeting on Thursday, the European Central Bank (ECB) seems prepared to cut interest rates again. Will this be the beginning of a series of rate cuts?

Current economic data shows that the economic situation in the Eurozone is more severe than it was at the last interest rate meeting, increasing market bets on a faster rate cut by the ECB. The rate cuts in June and September were conducted quarterly.

Regarding the rate cut pace of the ECB, Mark Wall, Chief European Economist at Deutsche Bank, stated:

"If the ECB does not cut rates in October, the market will think that the ECB is lagging behind the situation and may be making a policy mistake."

Here are five key questions that the market is focusing on:

1. Will the ECB cut rates this week?

It is almost certain that traders expect a rate cut of approximately 90 basis points, a probability that has surged from a low of 20% at the previous ECB meeting last month.

Unexpected contraction in Eurozone business activity in September has led to a significant increase in bets on a rate cut in October. Some policymakers have already indicated a rate cut in October, including ECB President Lagarde, who hinted that the confidence in the declining inflation will be reflected in the central bank's decision.

2. Does this signal the start of a series of rate cuts?

Yes, this is what Wall Street economists believe.

Traders expect more than three rate cuts in the four meetings after October, but ECB policymakers have not fully reached that point yet. Olli Rehn, Governor of the Bank of Finland, who holds a neutral stance, reiterated that the pace and scale of further rate cuts will be decided at each meeting.

However, Gilles Moec, Chief Economist at AXA, stated:

"Lagarde may be hinting that change is coming, and the December meeting may be the right time to truly change the future narrative."

3. Is inflation no longer a concern for the ECB?

Traders believe so. Inflation soared to over 10% two years ago but fell below the ECB's 2% target in September this year.

Even the stubborn core service inflation that ECB was particularly concerned about has slightly decreased. According to Nomura Securities, seasonally adjusted monthly data shows that service sector inflation has slowed to its lowest level since November 2023.

Data compiled by Danske Bank indicates that derivatives used to hedge inflation risks suggest that inflation growth will remain below 2% from the first quarter of next year, far exceeding the ECB's forecast in September. Even the long-time hawk Schnabel, who has been warning about price growth being difficult to control, has given up on the long-term warnings.

However, service sector inflation remains at 4%, not decreasing this year. The overall decline in September was driven by energy prices, so the ECB has not yet declared victory.

4. Is growth now the ECB's main focus?

This is an increasingly growing concern, as the question of whether economic stagnation will keep growth below target is the main challenge that the ECB has faced in the decade before the pandemic.

So far, the ECB has relied on real income growth to boost consumption and growth, increasing from 0.8% this year to 1.3% next year. Some economists are concerned that this forecast is too optimistic, as the German economy has shrunk for the second consecutive year Moec from AXA stated, if the expected economic rebound is not achieved quickly, there is a risk of inflation falling below the ECB target, which some policymakers are also concerned about.

5. Does geopolitical risk affect the ECB?

Yes.

Economists believe that since early October, with the escalation of geopolitical conflicts, oil prices have risen by over 9%, but are still more than $10 below this year's peak. Low inflation means the ECB can tolerate any temporary energy-driven increase.

Paul Hollingsworth, Chief European Economist at BNP Paribas in Paris, said:

The ECB's response has now shifted to focus more on growth risks, and geopolitical risks will only exacerbate some of their concerns.

More importantly, Thursday is the ECB's last meeting before the November US presidential election.

Economists are concerned that if Trump wins and fulfills his promise to impose a 10% tariff on imports from the eurozone, this will hit eurozone economic growth and provide further reasons for further interest rate cuts