MNI SOURCES: Chances Of October ECB Cut At Least 50-50

MNI (LONDON) - The European Central Bank's chances of cutting interest rates by 25 basis points in October are increasing after recent PMI and inflation data, with Eurosystem sources telling MNI the probability of such a move was 50% or higher.

September flash headline inflation was around 20 basis points weaker than expected across the board, with services and core gauges falling in most large economies, taking policymakers also rattled by the same month's weak PMIs by surprise. The likelihood of a cut is seen as 50-50 across the Governing Council, and its probability “is moving only one way,” one official said.

Another source said all indicators lean towards an October cut, which is now a more likely outcome than holding rates steady. An October move would align with the ECB's meeting-by-meeting, data-dependent approach, the source added.

“It’s not the weak headline number, but the declines in both core and services – although, to be fair, the French data could be an outsized move linked to a reaction to the Olympics. We can easily frame [a cut] as a reaction to CPI, PMI, borrowing data, etc., and not just one data point,” said one source.

Financial markets are placing a 90% chance on a 25bp cut in October, while comments from ECB President Christine Lagarde on Monday increased the buzz from market doves. Speaking at the ECON Committee in Brussels, Lagarde said the Governing Council would "take account" of recent developments at the next meeting.

"A CLOSE CALL"

Still, October’s outcome was a “close call,” the source continued, though the ECB’s communications could signal a significant shift in the balance of risks while adhering to continued data-dependence. While the language will be subject to debate, it is likely to leave the door open to a further cut at the next meeting in December. (See MNI INTERVIEW: ECB Likely To Hold In October - Gonzalez-Paramo)

There is little indication, however, that the Governing Council could follow the example of the Federal Reserve and respond to the low inflation data with a bigger, 50-basis-point cut, in October, with one source stressing that if in any acceleration in the pace of easing is required it was extremely likely to come via the channel of an increased frequency of 25-basis-point reductions.

“At the moment, I'd say it is a close call,” the source said, referring to the possibility of a 25bp cut. “Any cover needed to cut has been offered up by the data, although a wait until December will not be deemed a major issue.”

The poor data came as concern was growing over the potential for undershooting the inflation target in 2025 or 2026, with a source from a traditionally hawkish national central bank saying the fear of “falling behind the curve” was already increasing before the PMI data. Hawks, though, had argued that ECB projections for inflation to converge to target needed to be empirically supported by a fall in service sector inflation, with some pointing to over-optimistic assumptions about productivity growth.

Base effects on services inflation are expected to have a stronger impact next year, with part of the sector’s stickiness attributed to structural shifts in consumption toward leisure, a source from another national bank said.

An ECB spokesperson declined to comment.