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The European Central Bank and the Swiss National Bank both held their monetary policy meetings yesterday. They both lowered their key policy rate, but the size of the respective rate cuts and the communication differed significantly between the two. Indeed, the Eurozone and Switzerland face opposite challenges, with significant implications for their monetary policy.
The European Central Bank delivered a 25bp rate cut that was anticipated by financial markets, but ECB President Lagarde made a less dovish call than possibly expected given recent economic growth developments in the Eurozone. The clear deterioration in growth dynamics since last spring, with no signs of an imminent recovery, seemed to call for either an acceleration in the pace of monetary easing or, at the very least, a clear signal that the ECB was committed to decisive policy action. Unfortunately, inflationary pressures linger in the monetary union, with “core” inflation still above the ECB’s 2% target and wages’ growth unexpectedly accelerated over Q3. As a result, the ECB, whose first mandate is price stability, must maintain a balance between downside risks on growth and upside risks on inflation in its monetary policy assessment. The result was yesterday’s “cautious” 25bp rate cut, that leaves monetary conditions in restrictive territory, despite the weakness of economic activity in the Eurozone.
Higher growth and lower inflation in Switzerland than in the Eurozone
Source: Bank Syz, Factset Research
The European Central Bank has lowered its key interest rates by 25bp today, as widely expected. This fourth rate cut in six months now puts the deposit facility rate at 3.00%, and the main refinancing rate at 3.15%, their lowest levels since the first half of 2023.
These rate cuts aim at easing financing conditions in the Eurozone, as inflation is on track to stabilise around the ECB’s 2% target. However, as wages and prices in certain sectors continue to adjust to the inflation shock of 2022 and 2023, the ECB sticks to its gradual approach and leaves its monetary policy stance in restrictive territory for the time being, even if progressively less so.
Inflation and growth forecasts have only been marginally lowered compared to September’s forecasts:
- headline inflation is expected to slow down from 2.4% in 2024 to 2.1% in 2025 (2.2% previously expected) and to 1.9% in 2026 (no change compared to September’s projections)
- “core” inflation (excluding food & energy prices) is expected to slow from 2.9% in 2024 to 2.3% in 2025 (same as in September) and to 1.9% in 2026 (2.0% expected in September)
- GDP growth projections for the Eurozone have been slightly revised lower for the coming two years: after +0.7% in 2024, GDP growth is projected to pick up to +1.1% in 2025 (+1.3% expected in September) and to +1.4% in 2026 (vs +1.5% in September)
The ECB finds itself in an uncomfortable position as it faces a combination of stagflation and fragmentation pressures in the monetary union.
- The weakness of economic growth at the Eurozone level, below potential for a second year in a row in 2024 alongside an inflation rate still above the ECB’s 2% target. Given the ECB’s primary mandate of ensuring price stability, the central bank cannot afford to ease its monetary policy in response to weak economic growth if inflation remains above its target.
- On top of that, significant divergences are visible within the monetary union. The “core” of the Eurozone, Germany and France in particular, is experiencing multiple headwinds to activity and is on the brink of recession. In the meantime, peripheral economies such as Spain, Italy, and Greece, enjoy stronger growth dynamics, supported by their service sector.
This context prevents the ECB to ease more rapidly its monetary policy stance, which remains significantly restrictive: the policy rate is still above the estimated neutral rate level (1.5%) and the real short-term rate (ECB rate minus inflation) is still clearly positive.
In her press conference, President Lagarde outlined that risks to growth prospects are tilted downwards, as demand for labour continues to weaken and economy is losing momentum. While refraining from country-specific comments, one can easily guess that this statement particularly applies to the German economy, as well as the French.
However, as long as this weakness of the “core” is somehow balanced by resilience in the “periphery” (in a reversal of fortune from the 2010-13 period), the ECB has limited room for manoeuvre in relaxing its monetary policy stance, especially as inflation is still above its target and wages continue to grow at an elevated pace.
This is likely the explanation for the gradual approach followed by the ECB since the first rate cut of this cycle in June 2024. President Lagarde revealed that some discussions around a 50bp cut were held today, but that there had been an overall agreement that a 25bp cut was the right move.
Given the ongoing growth dynamics in the Eurozone, we believe that economic growth will likely continue to disappoint in the first part of 2025, especially if Europe must face an additional headwind in the name of US tariffs. This would be an additional blow to export-sensitive economies such as Germany. Prolonged weakness in activity will likely rapidly ease upward pressures on wages if the labour market deteriorates. Inflationary pressures will likely significantly ease as a result, paving the way for more ECB rate cuts, and possibly at a faster pace. The lack of support from fiscal policy in 2025, due to Germany’s debt brake and France’s already concerning public deficit levels, could rapidly put the shift the responsibility of supporting Europe’s economic growth back on the ECB shoulders, much like in the decade preceding the COVID pandemic. We see here a major difference when looking at the US economy, where stimulative fiscal policy is supporting growth dynamics and inflationary pressures and increasingly pushes the Fed to be cautious when considering rate cuts.
Yesterday’s decision also must be analysed in the context of ongoing developments in Europe. Political uncertainty and instability in France and Germany, worrying growth dynamics in Germany, that continues to err on the brink of recession, and easing inflationary pressures in the Eurozone will lead the ECB to ease significantly its monetary policy soon. A 25bp rate cut in EUR cash rate is expected later today, and more rate cuts will follow in 2025. To prevent an undue appreciation of the Swiss franc, the SNB needs to act boldly to maintain the EUR/CHF interest rate differential.
A return to negative interest rates in Switzerland is unlikely at this point, even if it hasn’t been ruled out by SNB Chairman Schlegel yet. Potential undue upward pressures on the CHF will then likely be addressed with interventions on the FX market and a possible expansion of the SNB’s balance sheet size. It would require a significant deterioration in global growth and inflation dynamics next year for the SNB to be pushed back into negative interest rate policies, which we believe is unlikely.
