ECB cuts 25 bps, paving the way for Powell

The European Central Bank (ECB) announced a 25 basis point (bps) rate cut, lowering its deposit facility rate to 3.5%, a widely expected move. This marks a significant development as it is the first time both the ECB and the U.S. Federal Reserve are expected to move in the same direction regarding monetary policy since 2022. This shift in central bank strategy comes as both institutions grapple with inflation and slowing economic growth. For the ECB, the focus remains on bringing inflation down to its 2% target, while also navigating weaker domestic demand and subdued economic activity across the Eurozone.

One of the key aspects of this decision is the ECB’s updated inflation outlook. The bank raised its inflation expectations for the upcoming months, largely due to base effects from last year’s significant drop in energy prices. President Christine Lagarde noted that inflation is likely to climb again in Q4, driven by these tougher year-over-year comparisons. However, the ECB views this inflationary spike as largely transitory, with underlying inflation expected to decline over time. Despite this, investors will need to remain vigilant as inflation risks persist, especially in the face of rising wages and persistent cost pressures in the Eurozone.

Lagarde emphasized that the decision to cut rates was unanimous, a signal of broad agreement among ECB policymakers. The central bank also updated its economic growth projections, lowering forecasts for each year through 2026. This reflects ongoing challenges in the Eurozone, with weak domestic demand and restrictive financing conditions weighing on economic activity. While the labor market remains relatively resilient, wage growth remains elevated and volatile, adding further complexity to the inflation outlook. Lagarde also noted that surveys indicate a moderation in labor demand, with risks to growth skewed to the downside.

A notable shift in this ECB meeting was the alignment with the Federal Reserve’s expected rate cut next week. For the first time in over a year, the ECB and the Fed appear poised to move in the same direction, signaling a coordinated global effort to address inflation while managing slowing economic growth. This alignment could have broader implications for global markets, as central banks across major economies are now more focused on fine-tuning their monetary policies to balance inflation control with economic stability.

However, despite the cut, the ECB has made it clear that it is not pre-committing to any specific rate path going forward. Lagarde reiterated that future decisions will be data-dependent and made on a meeting-by-meeting basis. While markets are pricing in two more rate cuts from the ECB before the end of the year, Lagarde cautioned that this is not guaranteed. The central bank remains attentive to both inflation risks and the need to support economic growth, meaning that any further rate cuts will depend on how inflation and growth data evolve in the coming months.

In terms of economic growth, the ECB noted that the Eurozone recovery is facing headwinds, with monetary policy restrictions still affecting private consumption and investment. The central bank cut its growth forecasts for every year through 2026, reflecting weaker domestic demand and the ongoing challenges in global trade. Despite this, Lagarde expressed confidence in the solidity of the ECB’s projections, suggesting that the Eurozone economy will strengthen over time as monetary restrictions begin to fade and financing conditions ease.

Looking ahead, the implications of the ECB’s move for the Federal Reserve are significant. With both central banks now cutting rates, the Fed’s decision next week will likely be scrutinized even more closely. While the ECB’s inflation dynamics differ somewhat from the U.S., the coordinated rate cuts could signal that both central banks are preparing for a more prolonged period of economic softness. For investors, the key takeaway will be how both the ECB and Fed manage the balancing act of controlling inflation while preventing a deeper economic slowdown.