Signs of a weakening European economy and fading inflation concerns have significantly strengthened expectations for an interest rate cut by the European Central Bank (ECB) in October.

On Wednesday, September 25th, HSBC's Chief European Economist Simon Wells and his team projected that the ECB would cut rates by 25 basis points at every meeting from October to April 2025, until the deposit rate falls from the current 3.5% to 2.25%. At that point, monetary policy should be close to neutral.

Johanna Kyrklund, Chief Investment Officer at Schroders, also believes that the ECB should cut rates at the October meeting, as the economic outlook has deteriorated. Kyrklund told Bloomberg TV reporters:

"For Europe, the environment remains challenging. Many trend indicators in Germany are not very good. Germany used to rely on cheap Russian energy, and this factor currently looks to be in poor condition."

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However, some policymakers have previously indicated that the likelihood of another rate cut in October is slim unless there is a severe deterioration in the Eurozone economy.

Currently, many market participants expect the ECB to cut rates in December, considering the possibility of a rate cut in October to be 50%. Klaas Knot, a member of the ECB's Governing Council and the hawkish Dutch central bank governor, stated last week that he is satisfied with market expectations.

Weak European economic indicators

In September, the Eurozone's composite PMI fell to 48.9, dropping below the boom-or-bust line for the first time since February, indicating a contraction in the economy and an increased risk of a significant slowdown in economic activity.

Simon Wells, HSBC's Chief European Economist, and his team pointed out that the preliminary PMI values for Europe in September were very poor—although the September PMI decline was in line with market expectations, it is clear that the magnitude of the decline indicates more than just the end of the Olympics.Therefore, the monetary policymakers of the European Central Bank (ECB) may relax policy earlier or more rapidly, with multiple interest rate cuts. Even the relatively hawkish Latvian policymaker Martin Kazaks recently stated:

"If interest rates remain too high for too long, it could lead to an unnecessary slowdown in the economy."

The ECB is increasingly confident in maintaining low inflation.

The ECB expects that inflation in the eurozone will be below target in 2026. Further weakening of demand prospects could increase the likelihood of substantial inflation falling below target. Therefore, even with the supply side remaining weak and the labor market gradually cooling, more policymakers may consider interest rate cuts as "insurance" to be necessary.

HSBC points out that deflation in commodities and the euro, good trends in wages and inflation expectations, and the weak eurozone economy all support the ECB adopting a more accommodative monetary policy. It would not be surprising if inflation fell below 2% in September. Knot said in an interview with a Dutch TV program on Tuesday that the ECB will gradually cut interest rates in the "near future" and in the first half of next year:

"As we become more and more convinced that the 2% inflation target is achievable, interest rates in Europe will continue to decline. But I don't think interest rates will return to the extremely low levels before the pandemic; they will stabilize at a more natural level, around 2%."