The consensus among analysts is that the ECB will be true to its word when it meets tomorrow, and not change policy. But, that doesn’t mean it’s going to be smooth sailing for the markets after the meeting. There are quite a few other issues that the ECB still has to deal with that could shake things up a bit. That could define whether the pullback through October was just a correction, or the beginning of a new trend.
Following its last meeting, the ECB essentially said that there would be no more rate hikes. That was despite inflation still more than doubling the target. However, there was a more pressing issue for the shared central bank: Economic indicators were showing that the region was at risk of falling into a recession. The data that has come out since has only deepened that view.
Calculating the Forward Risk
That’s not to say that the ECB definitively slammed the door on more rate hikes. It would be possible if conditions were to revert. And there have been some signs of that, as the price of fuel has risen in the wake of the Gaza conflict and worries that geopolitical tensions could escalate. Given Europe’s move away from Russian oil and gas, the continent is more vulnerable to supply shocks in the near term. That means the shared currency could come under pressure, since more Euros might be needed to buy energy.
It could also mean that the inflation that has been coming down could turn back around and rise. Normally, central banks ignore energy as a component of inflation, due to its volatility. But Europe can see a faster translation of energy costs into core inflation because the disruption of contracts last year left many major companies without hedging protection. That means the ECB could be paying more attention to the rise in energy prices.
What to Expect From the Meeting
It’s probably too soon for the effects of higher crude prices to be seen in Eurozone inflation data, but that doesn’t mean that the ECB might not want to get ahead of the issue and mention it. President Christine Lagarde will likely be asked about it in the post-earnings press conference, and how she answers could lead investors to recalibrate how likely the ECB is to reopen the hiking door.
There is another effect, as well: A slowing economy. Higher prices inevitably slow down monetary circulation. The most recent data – the flash PMIs reported yesterday – indicated that Europe is still facing the very real possibility of a recession. This could keep a lid on any further action by the ECB to try to reign in prices by slowing the economy. How this plays into the EURUSD is that the US saw improvement in its PMIs, suggesting that the American economy could keep growing.
The Widening Gap
The main issue for the Euro is if the ECB emphasizes concern over the economy, this could lead investors to worry the central bank could cut rates before the Fed does. That would widen the interest rate gap, and weaken the Euro.
On the other hand, there are still other tools that the ECB could address that would work to bring down inflation and support the shared currency besides rate hikes. That could be mention of further reductions to the balance sheet.
