Rates Spark: October ECB cut more likely than ever

With disinflation broadening across the eurozone and Lagarde underlining this will be taken into account in next decision, an October ECB cut suddenly seems more likely than before. After falling inflation numbers from France and Spain last week, now also Germany and Italy are added to that list. And Lagarde’s acknowledgements that the latest survey indicators (e.g. PMIs) are showing headwinds, adds to the probability that we’ll already see the next cut in October.

The ECB earlier appeared to resist the idea of an October cut, on the premise that no new projections would be available, but Lagarde’s speech appears to set markets up for another perfectly orchestrated cut. With 23bp priced for October, the strategy seems to work. Both cuts earlier this year were also fully priced in weeks ahead, avoiding any surprises on the day of the decision. In fact, market pricing is now almost at exactly one 25bp cut for each meeting until June 2025.

With markets dedicated to consecutive cuts for the six meetings, the next question to answer will be about the total number of cuts. In other words, the end point of the ECB. We likely won’t know the answer before approaching mid-2025 and therefore the coming months could see a shift of volatility from the front-end of the curve towards the back-end of the curve.

Considering the ECB’s dedication to staying ahead of the curve, and a front-end well-anchored to consecutive cuts, we think the next move will come from higher back-end yields. Frontloaded rate cuts should support the economic recovery quicker, boost financial conditions, and help risk sentiment in the near term. In addition, the currently implied terminal rate is now below 2.0%, which is too low in our view (and the ECB’s view) and should be closer towards 2.25%.