ECB Slashes Rates by 0.25 Basis Points for the Second Time

• The ECB has cut deposit rates from 3.75% to 3.5%.
• The slowing rate of inflation and fall in consumer spending have left the economy stagnant.
• These conditions indicate a hard landing for both the EU and the USA.

Credits: ECB

In what was a highly anticipated move, the European Central Bank (ECB) has cut deposit rates by 25 basis points - from 3.75% to 3.5%. However, the ECB has not committed to any rate path and said that any future decision will be taken on the basis of inflation assessment and economic and financial data.

This is the ECB's second rate cut in three months. The first one was in June when the bank cut rates for the first time since 2019 by 25 basis points - from 4% to 3.75%.

The second cut comes as inflation has slowed down, which is now near 2% and economic growth is struggling in the EU region.

Fall in Consumption

The ECB had hoped for consumption to increase in 2024, and set a target of 0.9% GDP growth. However, this hasn't happened. Retail sales rose by just 0.1% in the third quarter.

GDP increased only by 0.3% in the second quarter in the EU. Employment rates have also remained sluggish, increasing by just 0.2% in the second quarter.

This decreasing consumption can be attributed to falling incomes. As per a report, half of the OECD countries now earn less than what they did before the pandemic. People in the US and other European countries now have less disposable income. This has led to a fall in retail sales in the region since June 2024.

The job market hasn't helped either. As per Eurostat, the job vacancy rate was 2.6% during the second quarter of 2024, which is 0.3% less than the first quarter.

The slow consumption has also hit many retail and manufacturing industries. For instance, the capacities of ace automakers like BMW, Mercedes, Renault, VW, and Stellantis were underutilized during the last year. The sales have gone so weak that two VW factories in Germany are completely empty, with signs of permanent closure.

Inverted Yield Curve

The fear of recession looms large as can be seen by the inverted 10-2 Year Treasury Yield Spread. The current 2-year return stands at 4.55%, whereas the 10-year yield is at 4.11%. The curve turned negative in July 2023 and has remained that way since.

The 10-year-3-month Treasury Yield Spread is even worse, with the three-month yield at 5.47%. The curve has been negative since February 2020 and is currently twice as negative.

This means that the investors are expecting risks in the near future. Even historically, a period of recession is usually preceded by a negative yield curve. In fact, the 10-year-3-month curve has become negative before all 6 recessions in US history.

However, these inverted yield curves start un-inverting' just before a recession, which is mostly triggered by rate cuts - this is exactly what the ECB has done.

Hard Landing for the US?

The decline in economic conditions in the Euro region is no good news for the US either. Falling consumption, increasing unemployment, and slowing inflation are tell-tale signs of a hard landing, which eventually leads to a recession.

The situation hasn't quite improved since the pandemic. Data shows a 1% increase in household debt in the first quarter of 2024. However, the situation isn't as bad as in the EU. Retail online sales rose by 2% in June and wage increases have outgrown the inflation rates.

The US markets have also remained a mixed bag for economists.

• 59% of the S&P 500 companies posted better-than-expected results in the second quarter, which is less than the 10-year average of 64%.
• However, the EPS figures are encouraging, with more than 78% of companies exceeding expectations.

These mixed signals from the US economy have divided experts' opinions. While some say a hard landing is inevitable, others remain hopeful for a soft landing. However, the current EU economic turmoil can slowly cast its shadow on the US as well. As consumer expenditure slows down, the economy can become stagnant, which may lead to more rate cuts.

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