Eurozone and Swiss inflation point to more rate cuts

Contrasting October data

Inflation in the eurozone and Switzerland had contrasting profiles in October. In the eurozone, the annual inflation rate rose from 1.7% year-on-year (YoY) in September to 2.0% YoY in October, exceeding market expectations of 1.9%. In contrast, inflation in Switzerland fell from 0.8% YoY to 0.6% YoY against expectations of a stabilisation of inflation at the previous month’s level.

Central bank next steps?

Interestingly, markets responded by increasing the implied probability of a more expansionary monetary policy stance over the coming quarters in both economies. The common feature of the data releases is that both point to inflation being significantly lower than the most recent forecasts published by the ECB and SNB.

In the case of the ECB, the macroeconomic projections published in September predicted inflation averaging 2.6% YoY in 2024Q4. The October data suggests that even considering a marked adverse base effect linked to energy prices in the final two months of the year, inflation will not exceed 2.3% YoY on average in this quarter.

In Switzerland, the SNB's conditional inflation forecasts published in September saw an average inflation rate of 1% in 2024Q4. However, October’s data point to quarterly average inflation of around 0.7%, again anticipating a slight rebound in inflation linked to fuel prices.

Inflation projections

Markets therefore seem to be focusing on the divergence between the realised inflation rate and the central banks' short-term forecasts. Indeed, since the beginning of 2023 a relationship has emerged between the one-quarter ahead inflation forecast error of the ECB and the SNB and their subsequent decisions on interest rates (see Chart 1 a and b).

Chart 1a. ECB’s inflation projection (YoY)

Chart 1b. SNB conditional inflation forecast (YoY)

Source: ECB, SNB, LSEG Data & Analytics, and EFGAM calculations. Data as at 4 November 2024.

After inflation fell more than the ECB expected in early 2023, the central bank slowed the pace of monetary tightening during the spring and summer of last year when inflation outcomes remained slightly stronger than the ECB had anticipated. From the end of 2023, as inflation turned out lower than the ECB’s own forecasts and approached the 2% target, the central bank first stopped hiking rates before starting to reduce them since last June.

In Switzerland, inflation has been lower than the SNB's expectations since spring 2023, supporting a slowdown in monetary policy tightening from June last year and the end of interest rate increases after the summer. The continuation of downward inflation surprises, which had also seen inflation return to the SNB’s 0-2% target range, prompted the Swiss central bank to cut interest rates last March.

Expectations of further rate cuts in the eurozone and Switzerland are also supported by evidence that interest rates may be restrictive at their current levels. According to estimates from the ECB and the SNB, the neutral level of real short-term interest rates is around zero in both economies.¹ However, even after a cumulative reduction of 0.75% in the monetary policy rate by both central banks, the real three-month rate is above 1% in the eurozone and around 0.3% in Switzerland. Furthermore, both the ECB and the SNB expect inflation to moderate in 2025, which, in the absence of a recalibration of interest rates, would lead to a tightening of financial conditions.

Rate cut outlook

Looking at the coming months, the question for the ECB and the SNB will not be whether to cut interest rates or not, but to what extent and how quickly do it. In this context, we anticipate that in the first half of 2025 the policy rate will be reduced to 2% by the ECB and to 0.5% by the SNB, with risk tilted to the downside in both economies.

¹ The real rate is in this case calculated by subtracting the current headline inflation rate from the 3-month interbank interest rate.