(Bloomberg) -- Investors and economists can’t quite shake the idea that the European Central Bank will deliver a bigger cut in interest rates over the coming months.
Despite most officials favoring “gradual” — read quarter-point — moves, traders refuse to rule out a reduction of twice that size at one of the next three meetings.
They’ve zeroed in on a key market gauge of inflation expectations dipping below 2% and surveys pointing to dwindling economic activity in the 20-nation euro zone. Influential policymakers like France’s Francois Villeroy de Galhau have fed such bets. He’s urged his colleagues to retain full optionality on the size of cuts.
“I’d be willing to almost exclude a half-point step for December — even if the market still prices a chance,” said Christian Keller, head of economic research at Barclays. “The chances rise in the first quarter, but for now most signals point to the ECB continuing to cut rates at a gradual pace.”
It seems a 50 basis-point step will at least be debated when the ECB meets in Frankfurt on Dec. 11-12. While also warning of “still very high” uncertainty, Governing Council member Martins Kazaks said last week that officials will “definitely discuss this.”
They’ll do so because Europe’s economy is struggling to grow. Surveys of purchasing managers, while not proving the most accurate barometer of overall activity in recent months, point to problems in the private sector. Government collapses in Germany and France, meanwhile, are darkening sentiment in the bloc’s two largest members.
At the same time, there are grounds for caution on inflation — even as policymakers see it sustainably meeting their 2% target next year. Pay gains remain elevated, unemployment is at a record low and services prices continue to rise sharply.
“Growth would argue do 50 basis points, but the stubbornness of the ECB response function tied to past inflation remains the reason 25 basis points is probably where they end up,” said Jordan Rochester, head of macro strategy at Mizuho.
Most analysts agree. Only JPMorgan Chase & Co. has broken from the pack by bringing forward its call for a half-point decrease to this month, from January before, citing Europe’s fragile economy, moderating services inflation and uncertainty over trade.
Economists polled by Bloomberg predict quarter-point cuts at every meeting until the deposit rate reaches 2% in June. Earlier, they only envisaged that level being reached a year from now.
Updated ECB projections due this week — particularly for gross domestic product — may clarify things a bit. They’ll look ahead as far as 2027 and try to account for an ever-lengthier list of risks, from fiscal fears and trade tariffs to wars and geopolitical strife.
It’s with these highly unpredictable dangers in mind that ECB policymakers generally prefer to move step by step, without tying themselves to a firm loosening path.
“While I will say that we are on a disinflationary path and we know that the direction of travel is downward, the pace at which we move down the hill is not predetermined,” President Christine Lagarde told European lawmakers last week. “I’m not going to commit to any particular number, for sure.”
Other arguments against a heftier rate cut include the euro. The common currency has lost about 3% since Donald Trump sealed his return to the White House and, despite officials not targeting a specific level, the slide may pose fresh inflation worries.
More drastic action on rates could also signal to investors that the economy is in dire straits and that more 50 basis-point moves may be in the pipeline.
Economists at Nordea including Tuuli Koivu argue that a half-point step in December would set the ECB on course to taking rates below neutral — and potentially below 1.5%.
All that may explain why even the ECB’s most-dovish contingent hasn’t been very vocal on a bigger decrease. But it hasn’t stopped traders from positioning for such a scenario.
“By March, the disinflation process should have come sufficiently far enough for the Governing Council to become more forward looking, thus facilitating a larger rate cut,” said Jussi Hiljanen, chief strategist at SEB.
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