The case for another ECB rate cut in October

The September eurozone flash Purchasing Managers’ Index (PMI) surveys were concerning. Output across the manufacturing and services sectors unexpectedly fell and it did so at the fastest pace since the beginning of 2024. The contraction in manufacturing activity has extended to 28 months, only briefly and tentatively interrupted in early 2023. With new orders and the orders backlog falling at an accelerated pace, the odds point to manufacturing output remaining weak for the remainder of 2024 and into 2025. 

Activity in the services sector was also noticeably softer than in the prior few months, although it was reported to have grown moderately. The boost to activity from the Paris Olympic Games is now exhausted and, as with manufacturing, falling new orders and orders backlog components suggest the services sector and the broader economy have yet to bottom out (see Chart 1). 

Chart 1. Eurozone composite PMI orders and output

Source: LSEG Data & Analytics and EFGAM calculations. Data as at 24 September 2024.

The downside risks to eurozone gross domestic product (GDP) growth are evident. The level of the composite PMI in September is consistent with flat or slightly negative quarterly GDP growth (see Chart 2). Furthermore, in Germany the Ifo business climate index fell to its lowest since late 2022 and to a level not much higher than the trough in the aftermath of Lehman Brothers’ collapse.

Chart 2. PMI composite and GDP growth

Source: LSEG Data & Analytics and EFGAM calculations. Data as at 24 September 2024.

It is highly likely that the spell of soft growth that began in the last quarter of 2022 will continue until at least the end of 2024. This would mean that eurozone GDP growth will once again undershoot the European Central Bank’s (ECB) projections and it points to significantly reduced domestically generated inflationary pressures. 

That eurozone inflation is moderating was confirmed by decreases in the prices paid and received components in both the manufacturing and services sectors. In the latter, where inflation has so far remained stubbornly high, the PMI price indexes fell to their lowest since early 2021. Of note, the faster decrease in input prices than in output prices suggests that eurozone inflation could fall below the ECB’s 2% target much sooner and by much more than the central bank projected in September (see Chart 3).

Chart 3. PMI price gap and eurozone inflation

Source: LSEG Data & Analytics and EFGAM calculations. Data as at 24 September 2024.

After cutting interest rates on 12 September, the ECB stressed the need to keep monetary policy sufficiently restrictive for as long as necessary to return inflation to the 2% target in a sustainable way. It also noted the unusually short interval before the next monetary policy meeting on 17 October, leading many commentators to anticipate that policy rates will not be reduced before December. 

Nonetheless, the latest data point to a combination of weak growth and fading inflationary pressures that could be exacerbated by keeping monetary policy too tight for too long. To minimise such a risk, we believe that the ECB should cut rates again on 17 October.