Will the ECB Cut or Hold? Octa Analyst shares his Opinion Ahead of the 12 September Meeting

• Eurozone annual inflation decreased to 2.2% in August 2024. However, core inflation remains stubborn, easing by just 0.1 percentage point from 2.9% to 2.8%.
• The ECB has kept its main refinancing rate at 4.25% since 6 June, but shifting inflation dynamics might compel it to take action.This time, on 12 September, the ECB is highly expected to cut rates.
• However, they may keep being cautious and maintain the current rates to remain flexible for future monetary decisions. Yet, according to the Octa analyst, this scenario is unlikely to happen.

The European Central Bank (ECB) has been navigating a complex landscape of rising inflation and economic challenges. In recent meetings, the bank has been cautious, keeping interest rates stable despite pressure to act. However, the narrative may change in the upcoming 12 September meeting as Eurozone inflation sends mixed signals. While the Eurozone annual inflation fell from 2.6% in July to 2.2% in August, core inflation remains stubborn―dropping from 2.9% to 2.8%―mainly driven by persistent services costs. Previously, the ECB justified its decision to hold rates based on transitory inflation concerns, but recent data suggest these pressures may be more persistent.

The ECB maintains its restrictive monetary policy as they aim to return inflation to their target of 2%. However, they were expected to cut the rates several times in 2024. Since the cut didn’t happen in July, many believe it may take place in September. Policymakers note that it’s rather challenging to gradually ease restrictive policy when core inflation remains rather sticky on the downside. 

While the vast majority of economists believe that the rates are to be cut during the upcoming September meeting, the ECB may keep their cautious path and postpone rate changes. A decision to maintain the status quo could be seen as a commitment towards inflation-fighting despite lingering economic uncertainties.

'Recent Eurozone data highlights a complicated economic scenario for the ECB, characterized by blurred economic growth and elevated inflation figures. While headline wage growth in the Eurozone has declined, the wage dynamics in Germany, the region's largest economy, indicates persistent inflationary pressures', noted Kar Yong Ang, a financial market analyst at Octa. He added that the ECB faces tough decisions in revising its macro projections in September, potentially lowering growth forecasts while reassessing wage expectations. The challenge lies in balancing inflation control with economic support, making the rate cut decision more complex than markets anticipate.

If the ECB cuts the rates, the euro will likely weaken, which, in turn, may spur higher inflation in future. In this scenario, EUR/USD may break below the 1.10400 support zone and head lower. If the ECB keeps the rate unchanged, the euro will strengthen immediately, since many had anticipated a rate cut. In the unlikely scenario that the ECB opts for a rate hike, EUR/USD will sharply move to the upside, potentially targeting the resistance level of 1.1201.