Markets have pretty much come to the conclusion that the ECB to cut rates is highly likely when it meets on Thursday. That means that the focus is likely to be on what President Christine Lagarde will signal for future rate decisions. Though there is always the possibility of a surprise for the markets, the hawks winning out and keeping rates unchanged.
The thing is, it seems that there aren’t very many hawks left. Even Germany’s persistent voter for tougher rates Joachim Nagel said a couple of weeks ago that he was open to a rate cut. Analysts took note of comments by Lagarde in Parliament in late September where she seemed to pivot in her rhetoric. Instead of talking about “gradually” reaching the inflation target, she had confidence that the inflation would return to target “in a timely manner”.
Data Dependency and Trajectory
Lagarde could very well continue to stick to her stance that each meeting is on a case-by-case basis, and the Bank will decide depending on the data. That would likely convince the market that the ECB to cut rates is more probable, especially since the data so far has been inclined to the downside.
The flash September inflation reading popped below target to hit 1.8% (though it is expected to go back up in the next couple of months.) Southern nation representatives such as Italy’s Mario Centeno and France’s Francois Villeroy have a more urgent concern: The lack of economic growth. There has been a running (and public) debate between ECB board members over whether the shared economy will fall back into a technical recession again.
Not Quite There Yet…
The recent PMI figures continued to show persistent weakness in the manufacturing sector. On the other hand, services have remained in expansion, and prices there have been largely holding up inflation. The higher cost of energy has filtered through the economy, keeping price pressures in the service sector rising. That could be a reason for the ECB to hold off on a steeper cutting program. Particularly considering the still latent volatility in the Middle East that could push prices of crude (and therefore, inflation in Europe) higher.
In the really short term, oil has been falling, particularly following OPEC’s report that demand was expected to be weaker. Slow economic growth in Europe would contribute to lower energy prices, and thus lower inflation. Meanwhile, economists generally agree that the ECB’s higher rates are a drag on the economy. If the shared economy goes into the red when Q3 GDP figures are reported at the end of the month, the Frankfurt-based central bank could be under increasing pressure to ease.
So, To Parity?
Setting aside an unexpected rise in energy prices, analysts are suggesting that in the coming months could be a moment for the ECB to cut rates more aggressive cutting. With an anemic if not outright stagnant economy, the Euro could experience increasing weakness, particularly against its main trading partner: The US.
With the US economy remaining resilient, putting a floor under the Fed’s rate cutting program, the interest rate gap between the world’s two largest economies could widen. That would likely push the EURUSD lower in the medium term, opening the possibility of a return to parity. The raft of economic data for the third quarter coming out over the next couple of weeks could provide some clarity around how likely that scenario is.
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