JPMorgan has shaken the markets with a revised bet for the European Central Bank (ECB) to cut interest rates by half a percentage point next month.
The banking giant, originally expecting the move in January, now believes December will be the tipping point for a larger rate cut. Their reasoning? “Economic data is unraveling faster than anyone anticipated.”
Eurozone business activity shrank in November. Inflation in Germany missed forecasts, and the core inflation rate for the region didn’t budge as expected. These signals, according to JPMorgan, make a strong case for the ECB to take more aggressive action.
Traders wasted no time reacting. Money markets doubled their bets on a 50-basis-point cut, raising the odds to 20%, up from 10% just days earlier. German bonds followed, with two-year yields dropping five basis points to 1.95%—a level not seen since late 2022.
JPMorgan economist Greg Fuzesi, in a client note, explained the shift, citing several factors. The sharp decline in the Purchasing Managers’ Index (PMI), sluggish service-sector inflation, persistent trade uncertainties, and rates that remain overly restrictive formed the backbone of his argument.
Divided ECB leadership fuels speculation
The ECB is no stranger to mixed messaging, and this time is no different. Francois Villeroy de Galhau, a Governing Council member, called for continued rate cuts but stopped short of specifying the pace. He left the door open for future decisions to be based on evolving conditions.
Isabel Schnabel, however, had a sharper take earlier this week. She argued that borrowing costs were already near a neutral level, suggesting further cuts might not be as urgent.
Despite these differing views, JPMorgan’s Fuzesi thinks the data speaks louder than internal politics. “Even though internal dynamics in the Governing Council can at times result in hard-to-understand outcomes, the data have moved in a way that makes a 50bps cut compelling already in December,” he wrote.
The upcoming rate decision will mark the ECB’s fourth cut this year. Markets have largely priced in a smaller 25-basis-point reduction, but the case for something bigger is gaining momentum. Inflation in the eurozone climbed to 2.3% in November, back above the ECB’s 2% target. Core inflation—excluding volatile items like energy, food, alcohol, and tobacco—held steady at 2.7% for the third straight month.
The stickiness of inflation in services, which dropped slightly to 3.9% from 4%, adds another wrinkle to the ECB’s calculations. Economists had expected higher inflation in Germany, but it failed to materialize, adding more pressure on policymakers to act decisively.
Economic data sets the stage for December
The eurozone’s economic backdrop is looking shaky. Business activity, as measured by the PMI, continues to decline. Inflationary pressures, while ticking upward overall, remain uneven across sectors. The recent rise to 2.3% from 2% in October comes after months of softer figures, partly due to energy price deflation fading from the equation.
Despite this, the ECB isn’t operating in a vacuum. External factors, like the global fallout from Donald Trump’s recent election as U.S. president, add layers of uncertainty. Trade tariffs, if implemented, could choke European exports, further complicating the ECB’s task. These risks will weigh heavily on the central bank’s updated staff projections, expected just before its December 12 meeting.
Melanie Debono, senior Euro economist at Pantheon Macroeconomics, doubts a half-point cut is in the cards. She points to the bloc’s record-low unemployment and higher wage growth in the third quarter as factors that might hold the ECB back.
“The final decision will remain a close call,” Debono said, predicting the ECB will likely stick to a smaller 25-basis-point move in December, with similar cuts following in January and March.
Markets are jittery but remain cautious. Speculation of a larger cut faded after slightly improved growth forecasts and rebounding inflation in October. ECB policymakers, including Schnabel, have also stressed the importance of measured action, signaling that going big might not be the answer just yet.
Bond markets and political risks
Beyond inflation and growth concerns, the ECB faces pressure from bond markets. German bonds surged after JPMorgan’s report, but not everyone is convinced the central bank will intervene aggressively.
Governing Council member Joachim Nagel made it clear the ECB won’t act to address government bond fluctuations caused by political risks. Speaking in Frankfurt, Nagel said, “What happens with individual government bonds is typically a reflection of what may be happening politically in the country at the time.”
The ECB has tools like the Transmission Protection Instrument (TPI) to stabilize markets when monetary policy is at risk. Introduced in 2022, the TPI allows the ECB to buy government bonds under strict conditions. However, Nagel dismissed using this mechanism for political issues, saying, “It’s not the task of monetary policy to bail out individual countries.”
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