(Bloomberg) -- The European Central Bank’s third interest-rate cut offers traders some assurance — they can probably keep trusting their instincts for now with bets that a flurry of further moves is on the way.
Despite President Christine Lagarde’s well-worn, non-committal language on Thursday pledging “data-dependent” actions on a “meeting-by-meeting” basis, her descriptions of the shifting economic backdrop have essentially opened the door to more aggressive easing in the months ahead.
That follows a decision where investors correctly judged the way the wind was blowing, shifting pricing toward an October cut in reaction to souring business surveys and quicker disinflation well before policymakers accepted that a move they previously all but excluded was indeed about to transpire.
Money markets now imply a 20% chance of a half-point reduction in December and are almost fully priced for quarter-point steps at every meeting through April — representing a more drastic path for easing than they envisaged before this week’s decision.
With inflation set to settle at the 2% target sooner than earlier envisaged, officials consider another cut on Dec. 12 highly likely, according to people familiar with the matter.
If events turn out to resemble the view in markets, it may be a positive reflection of investors understanding the central bank’s reaction function and nimbly interpreting economic data and surveys in real time.
But it also raises the question of whether Lagarde and her colleagues are in the driving seat, and if they’re essentially in catch-up mode to the judgments of financial markets.
“The rate cut was absolutely appropriate,” said Karsten Junius, chief economist at Bank J Safra Sarasin in Zurich. “But we fear that the Governing Council remains behind the curve.”
Lagarde’s remarks to reporters Thursday in Ljubljana acknowledged a change in circumstances for the euro-zone economy, with disinflation “well on track” and the consumer-price outlook even subject to “downside risk.” Questioned repeatedly on the prospect of an outright recession, she saw that as unlikely.
“We are still looking at that soft landing,” Lagarde said. “On the basis of the information that we have, we certainly do not see a recession.”
Given the aggressive path for easing now seen by investors, they don’t seem so sanguine at a time when the region’s biggest economy, Germany, is suffering a second year of contraction and momentum appears to be fading elsewhere.
Market pricing “seems a little at odds with Lagarde’s assertion that she does not see a recession coming,” said Gareth Hill, a fund manager at Royal London Asset Management.
Aside from the possibility seen by traders of a bigger move in December, investor bets show the deposit rate falling from its current level of 3.25% to below 2% by end-2025. The euro slipped and short-dated bonds rallied as traders digested the new outlook.
“Lagarde largely failed to dissuade euro-zone rates markets from pricing even more aggressive easing ahead — to the detriment of the euro,” said Valentin Marinov head of G-10 FX strategy at Credit Agricole CIB.
Policymakers have reasons to be more hesitant, with the current monetary cycle having too often featured moments when single data points excessively shifted wagers on rates.
Similarly, they ended up cutting borrowing costs in June against their better instincts given the information available at the time, after having essentially pledged a move months beforehand.
That does leave the ECB in an uneasy position with regard to how far to follow investor expectations, and when to nudge them.
“The markets aren’t dictating our moves,” Bostjan Vasle, the Slovenian central banker who hosted Thursday’s gathering, told Bloomberg last week. But “they are valuable information to our deliberations.”
However awkward that leaves the presentation of policy for officials, some economists argue that tentative communication is still the right approach — even if financial markets are barely listening.
“The ECB continues to avoid guidance and is not committing to a particular path for policy,” said Mark Wall, chief economist for Europe at Deutsche Bank AG in London. “This is sensible given the uncertainties that lie ahead. But chances are that today’s decision represents a pivot point into a faster normalization of monetary policy.”
--With assistance from Naomi Tajitsu and James Hirai.
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