Will the European Central Bank opt for a large rate cut in December?

Market participants have raised their expectations for the European Central Bank (ECB) to take a significant step with its next interest rate move, following poor business activity indicators on Thursday. Money markets are now pricing in a 50% chance of the bank cutting the interest rate by half a percentage point in December. Meanwhile, ECB officials are divided on the necessity of such a large reduction.

Major European government bond yields fell significantly after the weak October business activity readings in the manufacturing and services sectors on Thursday. Movements in bond yields typically reflect expectations of the ECB’s interest rate trajectory, particularly for short-term instruments. The yield on the 2-year German and French government bond, which is highly sensitive to interest rate changes, fell to yearly lows before rebounding, indicating that traders have increased their bets on a larger rate cut from the central bank.

According to S&P Global’s flash estimates, the manufacturing Purchasing Manager Index (PMI) for both France and Germany has been contracting for more than two years in October, though Germany’s reading has improved. France’s services PMI is expected to slip back into contraction after two months of growth, suggesting that the boost from the Paris Olympics was temporary. This data, along with a sharp decline in headline inflation in September, has significantly raised the chances of the ECB delivering a steeper rate cut in December, following consecutive cuts in September and October—the first such moves in 13 years.

The eurozone’s annual inflation fell to 1.8% in September, its lowest level in three years and below the ECB’s 2% target. However, core CPI, which excludes volatile items like