ECB keeps rates unchanged, hints at potential September cut

The European Central Bank (ECB) left interest rates unchanged on Thursday, signaling a cautious approach following last month’s rate cut. With the economic outlook for the eurozone downgraded and inflation expected to decline further, ECB President Christine Lagarde emphasized that the September meeting remains "wide open."

The ECB’s decision to maintain current rates follows a contentious rate cut in June, which some policymakers felt was premature amid stagnant disinflation. However, Lagarde's comment that risks to growth are now "tilted to the downside" supports investor expectations of another rate reduction in September.

"We would conclude that a September cut remains firmly on the agenda," commented JPMorgan economist Greg Fuzesi.

Lagarde noted a slowdown in second-quarter growth, with weak investment and industrial output pointing to muted expansion ahead. This reinforces expectations that subdued economic activity will continue to alleviate price pressures, potentially allowing for further rate cuts.

However, Lagarde stressed that the ECB would not pre-commit to any rate path, letting upcoming data guide decisions. "So the question of September and what we do in September is wide open," she stated, avoiding any specific commitment that might corner the ECB into a particular course of action.

Her comments on wage growth, despite remaining high, also suggest that the ECB is leaning towards policy easing. Lagarde indicated that current wage growth and settled wage deals should align with the ECB’s inflation target by next year.

"We read all this as another sign that the ECB retains a dovish bias as it eyes a soft landing," said TS Lombard economist Davide Oneglia.

The euro eased slightly following the ECB's decision, which had been anticipated by markets. Analysts expect the ECB to consider at least two more rate cuts in 2024, contingent on forthcoming economic data.

The September meeting will coincide with expected moves by the U.S. Federal Reserve, adding further complexity to the ECB's decision-making. Markets are pricing in almost two ECB rate cuts for the rest of the year and more than five by the end of next year, a scenario unchallenged by ECB policymakers in recent weeks.

Quarterly figures on growth, wages, and productivity, along with two additional monthly inflation readings, will inform the ECB’s decision in September. New inflation and growth projections from the ECB will also be released at the meeting.

"As long as the inflation data is roughly pointing in the intended direction, the dovish-dominated ECB Governing Council is likely to cut its policy rates further at its next meeting in September," noted Commerzbank economist Joerg Kraemer. He added that additional cuts could follow in December and March next year.

The ECB remains concerned about domestic prices, particularly in services, and the risk of sustained high wage growth perpetuating inflation above target. Despite a relatively weak economy, with surveys indicating sluggish growth, there is cautious optimism that summer activity, especially in tourism, will not exacerbate price pressures.

Much of this remains speculative, as few concrete indicators have emerged since the June rate cut to validate projections. Some argue that the ECB may be underestimating risks to its central scenario, which aims to return inflation to 2% by the end of 2025, even as rates ease.