A factor that could boost bets on a European Central Bank (ECB) rate cut in October may come from the Federal Reserve... Traders on Thursday reduced bets on the ECB cutting rates again before the end of this year, as policymakers gave little indication of how much they are willing to ramp up monetary easing.

Sources also told Reuters shortly after the ECB meeting ended on Thursday that the bank is unlikely to cut rates further at its next meeting in October unless there is a significant deterioration in growth prospects.

The ECB cut its key deposit rate for the second consecutive meeting on Thursday, as expected, to 3.50%, but it reiterated that services inflation remains high and will maintain a sufficiently restrictive policy for as long as necessary.

Advertisement

ECB President Lagarde stated that the path of rates is not predetermined and that decisions on rates will be made on a meeting-by-meeting basis without pre-commitment.

Traders cut the probability of a 25 basis point rate cut by the ECB in October from over 30% before the meeting to around 20%.

For the remainder of the year, they now expect the ECB to cut rates by 33 basis points, down from 36 basis points earlier on Thursday.

Danish bank's chief analyst Piet Christiansen said, "Lagarde did what she wanted to do without rocking the boat in the market.

She seems satisfied with the current market pricing of around a 25 basis point cut per quarter."

As traders tempered rate cut expectations, Eurozone government bond yields soared.

The German two-year government bond yield, sensitive to ECB rate policy, rose nearly 10 basis points on Thursday, marking the largest one-day increase in nearly a month.

The Euro edged higher, and European stocks closed higher on the day.

With traders' confidence in the Federal Reserve's decision to start a series of rate cuts next Wednesday significantly strengthened, the market is focusing on how the divergence between the ECB and its peers will affect the market.

Traders expect the Fed to cut rates by about 100 basis points this year, with the first 25 basis point hike in September, implying a substantial 50 basis point cut at one of the remaining three meetings this year.

Traders believe that by the end of next year, the Fed will have cut rates 10 times, each by 25 basis points, while the ECB will have cut rates six times.

As exchange rate effects are the main channel through which the Fed's actions influence the ECB's thinking, analysts say the ECB will have to pay attention to a stronger Euro, which could lead to an unwelcome tightening of financial conditions in the sluggish Eurozone economy.

Christiansen said that a factor that could help boost bets on an ECB rate cut in October might be the Fed's "aggressive" decision next week, but the market currently sees only about a 20% chance of a 50 basis point cut.

Despite traders reducing bets on ECB rate cuts, analysts believe the Euro has little room for appreciation in the future.

A recent Reuters poll predicted that by the end of February, the Euro against the US dollar will rise to just 1.11, and to 1.12 after a year, not far from the peak touched in August.

James Athey, a fixed income fund manager at Marlborough, said that anyone long on the Euro will "rely on a fundamentally growth-friendly environment where the rest of the world outperforms the US."

Some investors say there is greater upside potential in Eurozone government bonds.

Eurozone government bonds have lagged behind US Treasuries, with smaller declines in yields this summer.

Fidelity International's multi-asset fund manager Mario Baronci said, "The safest part (in the bond market) is Europe.

If you look at the US Treasury yield curve, the market has priced in about 250 basis points of rate cuts over the next few years.

So, I prefer Eurozone government bonds."

As the ECB cut its growth forecasts for this year and next on the grounds of weak domestic demand, but still sees inflation reaching the 2% target in the second half of 2025, some investors are focusing on the risk that the ECB may be too slow to ease policy.

In fact, the Eurozone's recovery has been slow, with the German economy contracting in the second quarter.

Principal Asset Management's chief global strategist Seema Shah said, "If the ECB is slow to cut rates, the economy will not get the boost it needs."

"From a fundamental perspective, Europe is not as attractive to invest in as the rest of the world," Shah said, whose firm has reduced its holdings in European equities.