Policy Divergence Widens as Year-End Nears

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Eurozone Market Update

The ECB left the deposit rate at 2% in September, judging policy to be appropriately positioned. Inflation is broadly in line with the ECB’s 2% target, and 2025 growth prospects have improved. Staff projections had a dovish tilt, with 2027 inflation nudged down to 1.9% (headline) and 1.8% (core). Growth was revised up for 2025 (1.2%) but trimmed for 2026 (1%). President Christine Lagarde struck a firmer note, declaring the “disinflationary process is over” and cautioning that only persistent divergences would justify a shift. The flash composite Eurozone PMI rose to 51.2 in September, a 16-month high, led by Germany. France lagged at 48.4, highlighting regional divergence. France also saw political instability as the Prime Minister lost a confidence vote, and a Fitch downgrade to A+ from AA- added pressure. Though largely priced in, the move reinforced market sensitivity to sovereign credit risk, particularly at the long end of the curve.

_{Source: Bloomberg, data as of 30 September 2025}

UK Market Update

At its September meeting, the BoE’s Monetary Policy Committee (MPC) held the Bank Rate at 4% in a 7-2 vote, with two members favouring a 25 bps cut. The majority judged the policy to be sufficiently restrictive, citing persistent services and wage inflation, as well as only gradual labour market cooling. Services inflation eased slightly in August but remains high at 4.7%. Governor Andrew Bailey warned the UK is “not out of the woods,” adding that any easing will be gradual, careful and data-dependent. Markets now price the first cut in early 2026, with the likelihood of a 2025 move diminishing ahead of October’s OBR forecasts and the Autumn Budget in November. The February 2026 meeting, accompanied by updated projections, is seen as a more likely turning point. Regarding quantitative tightening (QT), the MPC also reduced its annual gilt runoff target from £100bn to £70bn. By lowering net long-end supply, the move should support market functioning amid elevated fiscal concerns.

_{Source: Bloomberg, data as of 30 September 2025}

US Market Update

The FOMC cut rates by 25 bps in September, its first cut of 2025, lowering the federal funds target to 4-4.25%. Governor Miran dissented, favouring a 50 bps move. The policy statement flagged a shifting balance of risks, with job gains slowing and inflation still firm. The updated dot plot (see Chart of the Month) in the latest Summary of Economic Projections showed a more divided outlook: the median projection points to two further cuts in 2025, though only one member sees more than 50 bps of easing. Chair Jerome Powell emphasised that policy is not on a set path, given the unusual tension between inflation and employment goals. Meanwhile, funding for federal agencies expired on September 30, triggering a shutdown of the US government. If prolonged, the Fed may enter its October meeting without labour or inflation prints. The economic impact of the shutdown will depend on its duration, but it is expected to be negligible this month.

_{Source: Bloomberg, data as of 30 September 2025}

Looking Ahead

As we enter the final quarter of 2025, monetary policy and fiscal politics take centre stage. In the US, the Fed has begun its cutting cycle. We expect two further reductions this year, followed by a slower quarterly pace in 2026. Chair Powell’s remarks support this view: while labour market risks are rising, the Fed remains focused on balancing both sides of its mandate. While the government shutdown may delay data releases, we do not expect it to derail policy, given moderating inflation and growth. In Europe, the ECB signalled stability, maintaining rates at 2% unless downside risks intensify. France’s challenging budget process increases the risk of further downgrades, exacerbating political tensions across the euro area. The BoE has entered a holding phase, weighing sticky services inflation and household expectations against easing wage growth. A slower QT should support gilt market functioning, but policy remains restrictive.

Chart of the Month

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