On December 12, 2023, at 21:15 Beijing time, the European Central Bank (ECB) will disclose its latest interest rate decisionThis critical announcement comes at a time when inflation has approached the ECB's target of 2%. Analysts widely expect that the ECB will execute its fourth interest rate cut of the year to alleviate the constraints that high borrowing costs impose on an already struggling Eurozone economy.

A majority of analysts surveyed anticipate a 25 basis point reduction, which would bring the deposit facility rate down to 3%. Yet, contrary to this consensus, analysts from JPMorgan are predicting a more drastic 50 basis point cut, citing recent data that illustrates a decline in both economic growth and inflation.

Concerns among ECB officials about the future economic landscape are palpable, with some expressing anxiety that prolonged economic stagnation could push inflation below acceptable levels

They are also grappling with political turbulence in major economies like Germany and France while assessing how the economic policies from the United States may reverberate through Europe and impact the Federal Reserve.

In this context, it appears that policymakers are leaning towards a gradual approach to reduce borrowing costsAlongside its interest rate decision, the ECB will release updated forecasts that may indicate that inflation and economic growth in the Eurozone are likely to weaken through 2025.

The discussions within the ECB became particularly heated prior to the third interest rate cut, which was moved forward to OctoberDuring that period, the Eurozone's economic situation was so dire that policymakers debated the necessity of an additional 50 basis point reduction to avoid falling behind the curveHowever, following better-than-expected GDP data for the third quarter, this debate settled, with only a handful of policymakers advocating a significant cut in December.

Despite the lack of urgency for a 50 basis point cut, investors are still wary

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Most market participants have ceased pricing in the risk of such a move, although they acknowledge the potential for it to occur in the near futureEconomists predict that the ECB will continue to lower rates in 25 basis point increments until the deposit facility rate reaches about 2%.

Even those within the ECB who usually lean towards a hawkish stance have come to an agreement that the cut announced this Thursday will not be the lastThere is a palpable tension regarding possible modifications to the vocabulary employed in the policy statement, particularly the current language that assures rates will remain "sufficiently restrictive as necessary". Nonetheless, the ECB is perhaps reluctant to stray from its historically consistent approach of making decisions in an iterative manner during meetings.

Looking ahead, policymakers are beginning to articulate their positions on whether interest rates need to descend below neutral levels

The inclusion of figures like Francois Villeroy de Galhau, the Governor of the Bank of France, and Fabio Panetta, the Governor of the Bank of Italy, in the ECB's decision-making body underscores the discussion’s significanceThey advocate that this possibility warrants serious considerationHowever, Isabel Schnabel, an ECB Executive Board member, has cautioned against extreme measures, arguing that overstepping could mean forgoing valuable policy leeways given the structural challenges that the economy fundamentally faces.

The ECB has historically relied on rising wages and increased household spending to bolster economic recoveryBack in September, the ECB projected growth rates of 1.3% and 1.5% for 2025 and 2026 respectively, an optimistic outlook compared to a more subdued growth of 0.8% anticipated for the current year.

However, recent Purchasing Managers' Index (PMI) data has shown a sagging manufacturing sector in the Eurozone, which is beginning to affect its service industries

This shift has led many observers to believe that the predictions made in September now appear overly optimistic, with most analysts forecasting a downward revision of the ECB’s growth projections for 2025.

On the topic of inflation, analysts expect the ECB to lower its inflation forecasts for both 2024 and 2025, while maintaining an average inflation rate of around 2% for 2026. Last month, Eurozone inflation slightly crept up to 2.3%, though it is widely regarded as being generally under control.

A notable limitation in this round of predictions is the absence of information regarding certain dynamics, like potential trade tensions with the United States and fiscal impacts in Germany and FranceThis oversight might be remedied by exploring alternative scenarios, a practice the ECB has occasionally employed in the past.

The political tumult in France has injected further uncertainty, as the parliament’s inability to agree on a budget has sent ripples through the French bond market, pushing yields to levels comparable to those of Greek bonds