Having left policy on hold in July, the ECB today delivered its second interest rate cut of the current cycle. The deposit rate, still the key due to the abundance of excess liquidity, was reduced by 25 basis points to 3.50 percent, matching both market expectations and its lowest level since June 2023. The decision was unanimous. The loose forward guidance from last time was retained, stating that the bank"will keep policy rates sufficiently restrictive for as long as necessary" to achieve the 2 percent inflation target.

The refi rate was reduced by a larger 60 basis points to 3.65 percent. However, while this might seem to make for a more aggressive ease, the move simply follows the bank's previously stated intention to narrow the spread between it and the deposit rate to 15 basis points by 18 September. It is the deposit rate that will determine where the level of short-term money rates settle. The rate on the marginal lending facility was similarly reduced by 60 basis points to 3.90 percent.

There was nothing new on QT which, since July, has encompassed the €1.7 trillion pandemic emergency purchase programme (PEPP) as well as the longstanding asset purchase programme.

Today's cut in rates will be seen as justified by the bank's new inflation forecasts. These show headline inflation at 2.5 percent this year, 2.2 percent in 2025 and below target at 1.9 percent in 2026, all unchanged from the June projections. Core inflation over the same period is put at 2.9 percent, 2.3 percent and 2.0 percent respectively. Both the 2024 and 2025 projections are slightly higher than last time but, crucially, the 2025 call is still on target. The bank noted that domestic inflation remains high due to elevated wages but still expects cost pressures to moderate going forward and reduced profit margins to buffer the wage impact on prices.

In summary, today's ECB statement contains no major surprises. The bank remains data-dependent and so, while leaning in the direction of lower interest rates, will not commit to further easing without the appropriate data. Investors will now turn to the next meeting in October when another cut is clearly possible. However, with the latest move consistent with policy changes being tied to the quarterly economic forecasting round, it may be that December is the most likely month for the next one.

With inflation easing and economic activity flat, the European Central Bank is widely expected to cut its key deposit rate by a further 25 basis points to 3.50 percent. This rate continues to steer short-term money rates due to the ongoing abundance of liquidity. However, note that as part of its March report on prospective changes to its operational framework, the bank indicated that by 18 September it would narrow the spread between the refi rate and the deposit rate (currently 50 basis points) to just 15 basis points. This would imply a larger, 60 basis point reduction, in the former to 3.65 percent.

The European Central Bank (ECB) sets monetary policy for all members of the Eurozone. The highest decision-making body is the Governing Council which comprises the six members of the Executive Board and the 20 presidents of member central banks. Policy meetings take place roughly every six weeks but, due to the sheer number of participants, a rotation system has been introduced so that the total number of votes is capped at twenty-one. The benchmark interest rate is the rate on the main refinancing operations (refi rate) which sits between the marginal lending facility rate and deposit rate. The ECB's primary objective is price stability which since July 2021 is based upon a symmetric 2 percent target for the annual inflation rate.

The European Central Bank determines interest rate policy at their Governing Council meetings. The Council is composed of the six members of the Executive Council and 17 presidents of member central banks (Bank of France, Bundesbank, etc). The Governing Council meets now meets every six weeks. The European Central Bank had an established inflation ceiling of just less than 2 percent which was modified in July 2021 to 2 percent. The ECB's measure of inflation is the harmonized index of consumer prices (HICP). Each member of the Governing Council has one vote and decisions are reached by simple majority. In the event of a tie, the President has the casting vote. Only short-form minutes are released so how individual members voted is not known.

As in the United States, European market participants speculate about the possibility of an interest rate change at these meetings. If the outcome is different from expectations, the impact on European markets can be dramatic and far-reaching. The rate set by the ECB serves as a benchmark for all other interest rates in the Eurozone.

The level of interest rates affects the economy. Higher interest rates tend to slow economic activity; lower interest rates stimulate economic activity. Either way, interest rates influence the sales environment. In the consumer sector, few homes or cars will be purchased when interest rates rise. Furthermore, interest rate costs are a significant factor for many businesses, particularly for companies with high debt loads or who have to finance high inventory levels. This interest cost has a direct impact on corporate profits. The bottom line is that higher interest rates are bearish for the stock market, while lower interest rates are bullish.