Photo by Mauro Sbicego on Unsplash
 

The just-released minutes of the European Central Bank’s October meeting reveal a more intense discussion and increasingly divergent views on inflation risks.

The ECB’s October meeting reaffirmed the central bank’s ‘good place’ stance, even though the phrase appeared only three times in the minutes and was never part of the official introductory statement. While most members seem to agree that downside risks have eased slightly, the minutes reveal a lively discussion on inflation risks, with views becoming increasingly divergent.

Here are some of the most relevant phrases from the minutes:

Philip Lane’s introductory statement to the discussion included a very slight easing bias. “The comprehensive assessment in December would enable a richer analysis of the appropriate monetary policy stance. In addition to the evolution of the baseline inflation outlook, shifts in the risk distribution would also matter for the Governing Council’s rate decisions: an increase in the likelihood or intensity of downside risk factors would strengthen the case that a slightly lower policy rate might better protect the medium-term inflation target; alternatively, an increase in the likelihood or intensity of upside risk factors would point in the direction of maintaining the current policy rate in the near term.”

ECB continues to see resilient domestic activity but acknowledges external risks. “The divergence of domestic and external demand was likely to persist in the near term, as the global environment would probably remain a drag owing to challenges from global trade frictions and geopolitical tensions.”

Investments still considered to be a growth driver next year. “Looking ahead, investment was likely to be underpinned by past interest rate cuts and substantial government expenditure on infrastructure and defence.”

Diverging views on inflation outlook. “Members assessed that the outlook for inflation continued to be more uncertain than usual on account of the still volatile global trade policy environment…Some members viewed inflation risks as tilted to the downside over the medium term relative to the September staff projections…A few members viewed inflation risks as tilted to the upside over the medium term relative to the September staff projections and noted that external forecasts for medium-term inflation stood above those projections.”
 

Watch out for definition of inflation undershooting at December meeting

The next ECB meeting is just three weeks away – almost an eternity in today’s fast-moving environment. Still, we are approaching the cut-off date for the ECB’s staff projections, which are now more crucial than ever in deciding whether or not to keep interest rates on hold. Technical assumptions have barely changed since September’s forecast, with only oil prices slightly lower. The most significant shift stems from the decision by European leaders to postpone the second phase of the EU Emissions Trading System (ETS2) from 2027 to 2028. Although the European Parliament must still approve this delay, it carries major implications for the ECB. In September, the ECB projected inflation at 1.7% in 2026 and 1.9% in 2027. Without the ETS2 implementation, inflation in 2027 would remain at 1.7%. This raises the question of how the ECB defines inflation undershooting. If projections fall below 1.7% for both 2026 and 2027, the likelihood of another rate cut would definitely increase.

All in all, for the time being, we stick to our call that the ECB would prefer to leave interest rates untouched for the next two years. However, at least in the nearer term, the door for rate cuts remains open.

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