Playbook for the October ECB decision
The October meeting of the ECB is as interesting or exciting as last month's surprise 25bp rate hike. Instead, the Governing Council is likely to make a relatively simple decision, involving no changes to the policy tools, while the discussion on some more nuanced areas of the ECB's working tools is unlikely to reach definitive conclusions until the December decision. As already mentioned, the deposit rate will be kept this time at the record level 4.00%. In reality, money markets do not foresee any possibility of movement or further tightening, demonstrating the firm belief that the terminal rate has already been reached.
Interestingly, however, the OIS continues to price the first deposit rate cut for July 2024, even though it sees a ~80% chance that such a 25bp cut could happen as early as next June. This seems at odds with the Governing Council's current guidance that rates should remain at "sufficiently restrictive levels for as long as necessary". This week's decision appears to be a repeat of that direction, along with a reiteration of a commitment to setting policy in a data-dependent manner, both in terms of the level of rates and how long they remain at that level. This meeting offers policymakers a moment of pause to take stock of recent economic developments, while maintaining the possibility of raising rates further should inflation bite again.
As for economic developments, incoming inflation data has started to move in a more promising direction for the ECB. Both headline and core CPI fell back below 5% year-on-year in September, with the headline measure hitting a two-year low, while the rapid decline in producer prices indicates disinflation will continue in the coming months. However, risks remain tilted to the upside, with the labor market remaining relatively tight across the bloc, plus geopolitical developments in the Middle East posing the risk of the bloc facing an energy supply shock for a second winter consecutive.
Of course, the geopolitical situation remains uncertain, and it is still too early to assess the macroeconomic impacts of the current conflict. However, while risks to the ECB's inflation projections, which already expect the CPI to remain above the 2% target until the end of 2025, remain tilted upwards, risks to GDP growth block continue to be inclined downwards. Indicators continue to point to contraction in both the manufacturing and services sectors, with September PMI readings remaining below the key threshold of 50, while October data - which precedes the ECB's decision by two days - are intended to paint a similar picture. Of course, rising geopolitical tensions and the continued lack of a concrete economic recovery in China are also obstacles.
It is in this context that even the hawks of The Governing Council will probably be content to sit on their hands this month. Nonetheless, some of the more complex areas of the ECB's working tools, namely minimum reserve balances and the reinvestment of expiring PEPP bonds, are likely to be discussed, although decisions on these are unlikely until the last meeting of the year, in December.
Overall, with little change in policy or concrete guidance likely to be produced by the October meeting, it could prove to be a meeting with limited, if not prolonged, impact on the euro. Indeed, ahead of the decision, one-week EUR/USD implied volatility remains below the 20th percentile of its 52-week range, indicating less than a large-digit move over the next five trading days (with 1 confidence standard deviation). In terms of levels, 1.0650 remains the key upside level that Euro bulls will have on their radar, especially with the common currency heading into the ECB meeting on the back of its best week since July; the 50-day moving average, which spot hasn't traded above since August, sits just above at 1.0685.
On the downside, 1.05 remains key psychological support, with a break close below that level potentially opening the door to a retest of the previous low of 1.0450, before a further decline towards 1. 0355. At the moment, the balance of risks indicates that the most likely direction of travel is down.