Bottom line: The ECB cut interest rates by 25 basis points today, speeding up from a quarterly pace, due to slowing growth, weaker employment and inflation undershooting its projections. The jury is still out on how long the ECB will stay in this faster lane. The ECB could cut again at its December meeting: rates are still highly restrictive, and it has more room to ease than the Fed, having tightened policy more. But for now, only a further sharp economic deterioration would prompt the ECB to increase the size of coming cuts. We think it is unlikely to cut far – i.e. beyond neutral – given sticky domestic inflation. We maintain our preference for income in short-dated euro area bonds over short-dated U.S. Treasuries.

Moving into the fast lane.... As expected, the ECB cut rates by 25 basis points today, speeding up from a quarterly pace of cuts in June and September. That’s due to slowing growth, weaker employment indicators, and inflation undershooting the ECB’s projections. President Lagarde reiterated that the ECB would follow a “data-dependent, meeting-by-meeting approach”, and did not rule out a December cut. The ECB has more confidence in its projection for inflation to return to its 2% target in the second half of 2025, so we think a series of consecutive cuts is likely. We think only a further sharp economic deterioration would prompt the ECB to increase the size of coming cuts and rush to take rates below neutral.

… but not going far. The ECB has more room to ease than the Fed, having tightened policy more. But like the hiking cycle, this is not your typical cutting cycle: This is not a return to the world we once knew, where inflation was consistently well below the 2% target. With easing but still-tight labour markets and productivity weak, domestic price pressures could keep inflation near or above 2%. We think wage growth will cool further, but services inflation is still too high at roughly 4% in September. Given the ECB raised rates into highly restrictive territory, even if it has moved into the fast lane, we still don’t think it will drive too far. We don’t think the ECB is going back to the old regime of very easy policy. Consecutive cuts would still leave policy weighing on growth well into 2025.

No big surprise for markets, for now. Markets now expect back-to-back cuts, taking the policy rate roughly to neutral in the second half of 2025. Investors should keep the big picture in mind: even rates close to neutral would be structurally higher than before the pandemic, supporting the appeal of income. On a tactical horizon, we prefer income in short-dated euro area bonds and credit over short-term U.S. Treasuries. We think markets are still pricing in too many Fed rate cuts. We remain tactically neutral long-term euro area government bonds. We still favour U.S. stocks over Europe’s on stronger corporate earnings and the AI theme.