ECB cuts rates, forecasts weaker economic outlook

The European Central Bank (ECB) elected to cut rates by a quarter-point this week, lowering its deposit rate from 3.25% to 3% based on expectations of a slower economic recovery amid falling inflation. 

This is the fourth cut the ECB has made to interest rates this year. Bank staff now see headline inflation falling to 2.1% in 2025, with GDP growth expected to come in at 1.1% next year. Staff previously anticipated that the economy would grow 1.3% in 2025. President Christine Lagarde said there is evidence firms are holding back their investment spending in the face of weak demand and a highly uncertain outlook.

Orla Garvey, Senior Fixed Income Portfolio Manager at Federated Hermes Limited, says it is notable that the ECB statement appears to be keeping the door open to additional rate cuts.  

“A lot of what we heard was widely expected. However, the reference in the statement to keeping rates restricted was removed, which confirms the expectation for further cuts, but implies cutting to neutral rather than stimulating growth,” she says. “Also interesting were the medium-term inflation forecasts which showed headline inflation averaging 2.4% in 2024, 2.1% in 2025, 1.9% in 2026 and 2.1% in 2027. Core inflation is expected to average 2.9% in 2024, 2.3% in 2025 and 1.9% in both 2026 and 2027. Expect a lot of discussion on where ‘neutral’ is going forward.”

Federal Reserve expected to continue easing

A minor rise in US inflation looks unlikely to deter the Fed from cutting rates again at the December meeting. The US consumer price index (CPI) rose 2.7% in the 12 months to November, according to data from the Bureau of Labor Statistics. The reading was marginally higher than the 2.6% rate recorded for October and remains stubbornly above the Fed target of 2%. 

However, the latest figures appear to satisfy the requirements for another interest rate cut when the Federal Open Market Committee (FOMC) meets on Wednesday December 18 for the final time this year, says Damian McIntyre, Porfolio Manager at Federated Hermes.

“Prior to the December 11 CPI report, the market was pricing in an 86% chance of a December rate cut; now, the market is pricing in a 97% chance,” he adds.

Another cut would be the third of 2024, following a half-point cut in September and a quarter-point in November. The target range for the federal funds rate currently stands at 4.50-4.75%. What is now less clear is what direction the Federal Reserve will take in 2025.

“Progress on reducing inflation has certainly stalled. The runway is shortening, leaving Fed Chair Powell to face even tougher rate cut choices in the near future. Markets are already pricing in a likely pause in January and three cuts in 2025,” McIntyre says.

The situation only adds to the growing sense of macroeconomic and geopolitical uncertainty as we head into the new year. However, short-term rates currently stand out as both attractive and a way to potentially shield against heightened volatility, says Ihab Salib, Senior Portfolio Manager and Head of International Fixed Income Group at Federated Hermes. “Short-term rates, both in the US and Europe, are probably the most attractive they've been in a decade. I don't know what's going to happen next on inflation, or in terms of global growth, but I do know that rates are attractive right now in this space and also present a means to avoid some aspects of the current volatility.”