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ECB Rate Cut a Done Deal: Then What?

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ECB Rate Cut a Done Deal: Then What?
According to both the markets and economists, it is virtually certain that the ECB will cut rates tomorrow. Which means if it does, the focus will turn to the potential rate path after that. Analysts and traders will be closely scrutinizing the monetary policy statement, and perhaps more importantly, ECB President Christine Lagarde’s post rate decision press conference.

That’s because after June, the consensus goes awry. A more hawkish indication could keep the Euro on the stronger side. But if the doves prevail, then we could see the Euro turn around and trend lower against its peers. That latter scenario opens up substantial downside, as the market is increasingly uncertain about whether the BOE and the Fed will come through with rate cuts later this year.

Where the Differences Lie

Up until last week, the consensus was pretty solid about the path forward. Then the latest employment data came out, showing that wage growth remained elevated. That caused the market to pair back its easing expectations, giving the Euro a boost. It’s possible that the ECB could address this wage pressure point, and reassure the market. That could leave the Euro weaker following the rate decision.

Economists and the markets are at odds about what happens after the June meeting. There is a strong consensus among the economists that there will be two more rate cuts (for a total of 75bps in the year). The markets had been pricing that in until last week. Now, futures markets see only two rate cuts this year: The one now in June, and another in October. That 25bps of difference in the forecast could be what determines the outcome of the ECB meeting.

Where the Price Action Risk Is

If the markets feel vindicated in the statement, then then there likely won’t be all that much of a move in the Euro. But if the economists are proven to be more correct, and the ECB comes out more dovish than expected, then the markets could turn downwards in response. In summary, that means the risk of price action following the interest rate decision is to the downside.

Of course, in anticipation of this, markets could price in the potential action and trend lower ahead of the post rate decision presser. That’s when the market is likely to be expecting potential guidance, since Lagarde will have to change her rhetoric about the future of rate policy. Until now, her position has been that the ECB has to wait to get all the data from Q1 in order to decide whether to cut or not. Once it gets around the cut, then she will have to provide a balance of future rate policy. With that in mind, it’s through the course of Lagarde’s press conference where we could see the most volatility.

There Are Other Factors Pushing the Markets

The other thing that could provide some uncertainty and volatility to the Euro in the coming days is the European Parliament elections which will conclude over the weekend. Typically, the elections have little effect on the markets, because of the relatively limited power of the Parliament, and the polls providing a solid lead to the EPP. That would likely see European Commission President Ursula von der Leyen confirmed in her job for another five years.

But if any guidance can be taken from local and national elections, a swing to the right in the election results could be one of the surprising outcomes. That could end up shaking up markets a little bit, as markets recalibrate how it could impact policy.

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