On Thursday, the EURUSD came down to test the 1.05 handle, the lowest it has been since October of last year. This came amid renewed speculation that the ECB could be headed for strong rate cuts at the next meeting. Some analysts have gone so far as to speculate that a return to parity with the dollar could be in the near future.
The shared economy is facing a particular array of challenges in the coming months that could further weaken the currency. Already having sluggish growth, the threat of a trade war with the US looms large. European authorities are already preparing potential retaliatory tariffs against the Trump administration, something that is starting to worry central bank officials. European companies are wary of the situation, and that could mean they are conserving capital. German industrial names in particular – with car exports to the US a major factor – have been underperforming.
The ECB Response: Confusion
Amidst this backdrop, the ECB is giving off a public appearance of not knowing what to do. Policy board members have been quite outspoken in the days since the election of Trump, but haven’t addressed the situation directly. That is natural for central bankers to try to stay out of politics, particularly in another country. However, they do have to address the ramifications for monetary policy.
The usual hawks and doves, north and south divide has manifested itself. Germany’s Isabel Schnable, for example, talked down the usefulness of quantitative easing (QE) in terms of stimulating the economy. Spain’s Luis de Guindos said that there had been good progress on inflation, but warned that the economic situation was complicated. Hawks look to suggest that steady currency and monetary policy is the best tool to allow the economy to rebound. Doves are trying to make the case for drastic rate cuts to goose the economy. The market, it seems, has been pricing in the latter taking the lead.
There Are Cutting Rumors
Press reports on Thursday suggested that “insiders” expect the ECB to cut rates for several consecutive meetings going forward. According to those reports, a 25 bps cut in December followed by a similar amount in March was a “done” deal. Another cut in January was “almost” just as likely.
Markets are pricing in 125 bps of rate cuts from now to the end of 2025, with a heavy weighting to the start of the year. In contrast, markets see only 75 bps of cuts from the Fed. This would substantially widen the interest rate gap between the currencies, making the dollar more valuable than the Euro and pushing down the currency pair.
How Low Can It Go?
A lot seems to be rising on the expectations of tariffs, but that won’t be knowable for sure until January 20th when Donald Trump takes office. But the prospect has the ECB worried. Even Germany’s representative at the ECB Joachim Nagel said that the imposition of tariffs will be highly negative for the economy, potentially pushing it into recession. That implies that the hawks might shift their tone about rate cuts starting next year.
In the meantime, there is still a large batch of data for ECB Governing Council members to process before they decide what to do at the next meeting. Although the consensus is still for a 25 bps cut, some traders are starting to get convinced that 50 bps is well within the realm of possibility.