What to Expect from ECB’s Lagarde This Week

In the aftermath of last week’s rate decision, ECB President Christine Lagarde will make a series of closely-watched speeches in the coming days. She will have a difficult task of both communicating the central bank’s moves while at the same time not spooking markets. After completely fading the move following the rate decision, clearly markets are looking for more information to figure out where to send the EURUSD.

Last week, the ECB did the first back-to-back rate cut in 13 years. Despite the echoes of the 2011 Euro crisis, Lagarde insisted that the shared economy is on track for a “soft landing”. But analysts are acutely aware that the move likely represents a shift from dealing with inflation to dealing with lack of growth. Europe’s economy has lagged the US for the last two years, despite lower interest rates. The question for traders is where does the trend go after this.

A “Soft Landing”

The natural driver of inflation is economic activity, which is one of the reasons why restrictive monetary policy works in the first place. GDP growth pushes increased monetary circulation and creation in banks as people and businesses borrow to expand capacity. Naturally, if the economy isn’t growing, then this inflationary pressure dissipates. But, there are other ways to generate inflation, such as higher costs of energy, or increased deficit spending. Those causes are often less responsive to interest rate policy.

Lagarde has acknowledged along with most of her Board colleagues that Europe is facing inflation in large part due to higher energy costs. The ECB’s rate policy will have little effect on OPEC+’s decision to curtail production of oil to push up prices, nor the conflict in the Middle East, which is forcing oil shipments around the Cape, raising prices for European customers. In other words, cutting rates won’t be inflationary if the cause of the inflation is outside of the control of the central bank.

The Outlook: More Cuts

Following the rate decision, Lagarde didn’t provide any clues as to whether there will be another rate cut in the final meeting of this year. Governing Board members such as Slovenia’s Bostjan Vasle from the more hawkish side were quick to clarify that just because there were two consecutive rate cuts, it didn’t mean it was a start to the trend. On the other hand, his Latvian colleague Gediminas Simkus said that rates might have to go down below the “natural” level. The implication is that the divisions in the central bank remain, despite last week’s cut.

But, the markets seem to be aligning with the doves, with figures suggesting that there is a more than 50% chance that not only will the ECB cut, but it will do so at an accelerated clip of 50bps. In fact, of the three largest central banks (BOE, Fed, ECB), the markets think the ECB is the most likely to do a “double” cut.

What Could Move the Markets

The expectation is that Lagarde will keep with her rhetoric suggesting that inflation is on the right path to be controlled. Inflation might rise a bit for technical reasons, but will subside. But the market might be more interested in what she has to say about the economy.

The consensus is that the ECB is now more worried about slowing growth, so an admission from Lagarde that something needs to be done to shore up growth could convince the market that more easing is on the way. On the other way, keeping her focus on inflation could leave markets fading recent weakness in the markets, and pair back bets of easing in the coming meetings.

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