We expect the European Central Bank to cut rates by 25 basis points at its December 12 meeting, bringing the deposit rate down to 3%.
- Eurozone growth has continued to disappoint since the last meeting in October, and future tariff risks after the US election result add further uncertainty to the euro’s growth outlook in 2025.
- We do not believe the ECB will increase the pace of its policy until future US trade policy becomes clearer.
- In recent weeks, short-term interest rate markets have begun pricing in downside growth risks for the region in 2025; the deposit rate is pegged at around 1.80% by June 2025 and two-year Bund yields are also at their lowest level in two years.
- We favor a steepening of the German yield curve in the short term, but recognize that a lot of bad news is now well priced in interest rate markets.
Eurozone data suggests regional activity slows in the fourth quarter of 2024, with surveys of manufacturing activity remaining weak and clouds also gathering in the services sector. Consumer confidence is crumbling and labor market data shows some deterioration, with surveys painting a picture of slowing job growth. On the inflation front, the general scenario of disinflation remains intact, with inflation of the overall CPI (Consumer Price Index) and the core CPI in euros standing respectively at 2.3% in year-on-year and 2.7% year-on-year in November. In the short term, the structural challenges, trade uncertainty and political paralysis facing the region – pending German federal elections in February and the outcome of the French budget process – paint a rather bleak picture of the European outlook. by 2025.
While recent activity data in the region does not rule out a 50 basis point cut at the December meeting and a more rapid withdrawal of the restrictive policy stance, recent comments from some policymakers in the ECB varied regarding the trajectory of future rates. Ms. Schnabel, a member of the board of directors, notably pleaded in favor of a more gradual approach, because she fears that the path towards inflation at 2% will still be strewn with pitfalls in 2025. She also believes that the impact of tightening ECB’s past will fade quickly.
The news is not all bad for the region heading into 2025. Financial conditions are easing, helped by expectations of ECB rate cuts and the weakening of the euro. The ECB’s most recent bank lending survey also highlighted improving loan demand in the region, while the prospect of debt brake reform in 2025 could give the German government some fiscal space to address the structural and cyclical challenges facing the economy.
-Nevertheless, much will depend on the future tariff policy of the United States; Widespread tariffs on China and Europe could quickly derail hopes for a lasting recovery in the region.
From a strategic perspective, we favor a steepening of the German short-term yield curve, but we recognize that a lot of bad news is now well priced in interest rate markets.
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