European Central Bank set for a rate cut in September, economists predict

The European Central Bank (ECB) will next week open the door to an interest rate cut for September, economists have predicted.

The ECB’s governing council is set to meet next Thursday in Frankfurt after euro zone inflation data for June came in higher than expected this week at 1.3%, but remained well below the central bank’s target rate of just below 2%.

The ECB is juggling political uncertainty and an economy sluggishly battling external weaknesses, which have led to a dovish tone of late from its President Mario Draghi.

S&P Global Ratings economists Marion Amiot and Sylvain Broyer expect the ECB to cut its deposit rate by 10 basis points following its September meeting, and potentially resume quantitative easing (QE) in the form of 15 billion euros ($16.85 billion) in asset purchases in October. The deposit facility rate defines the interest banks receive for depositing money with the central bank overnight, and has been negative since June 2014.

“The European economy is still evolving at low gear and two speeds, with robust service activity on the one side but no obvious recovering in manufacturing on the other,” Amiot and Broyer said in a note Thursday.

The German and Italian economies, considered Europe’s premier manufacturing powerhouses, are hovering close to recessionary territory and remain susceptible to several external risks, such as Brexit, the U.S.-China trade war, Iran, a Chinese economic slowdown and potential U.S. tariffs on European car imports.

The S&P economists project that manufacturing weakness is likely to weigh on the robust service sector, suggesting we could see “more downward revisions to growth and inflation forecasts this year.”

The current ECB interest rates on its main refinancing operations, marginal lending facility and deposit facility sit at 0%, 0.25% and -0.40% respectively. Against the backdrop of a global slowdown and weak inflationary pressures, S&P expects the ECB to adjust its forward guidance next Thursday to accommodate a rate cut of 10 basis points (bps) in September.

“A downward bias would allow the ECB to cut rates as soon as September 2019, if the euro strengthens on looser policy by the U.S. Federal Reserve System and market-based inflation expectations do not increase markedly from their current lows,” the note explained.

It added that because the ECB lengthened the timeframe of its forward guidance by one year in June, this meeting would be too early to alter that aspect of the guidance again. However, S&P anticipates that the ECB will “have more work to do in the future on its communication” given the slow development of the euro zone economy.

Amiot and Broyer do not expect the central bank to be able to raise rates again until at least the second quarter of 2021.