Both the markets and economists are universal in their agreement that the European Central Bank (ECB) will cut rates. But there seems to be an open debate among ECB officials themselves over how much it should be. In either case, the market is projecting a dovish tilt to the upcoming meeting, which ironically creates the conditions for a rebound.
The EURUSD had been trending downward for two months in the late summer and fall. But then came the latest GDP numbers, where Europe accelerated and the US slowed down. Since then, the currency pair has managed to rebound a bit, and talk of parity has become a lot quieter. The move, however, suggests that economic growth more than inflation is driving the price of the currency. Which has some important implications for how the market reacts to what the shared central bank does.
What Are the Forecasts
Nearly all economists in the latest survey agreed with a prediction that the ECB will cut by 25 bps at the conclusion of its meeting on Thursday. The tiny number of dissenters are in favor of a 50 bps cut. The markets are slightly more dovish, pricing in a 90% chance of a quarter-point cut; and a 10% chance of a half-point cut.
What this means is there is room for a move in the currency no matter what the ECB decides. Even in the most likely scenario, that Lagarde & Co go for the 25-pointer, then the markets will likely reprice that 10% dovish chance, giving the currency a bit of a boost. On the other hand, if the ECB does go through with the half-pointer that many in the “southern” countries are asking for (lead by France’s Villeroy), then the market will have a bigger move downward to reprice the 90% prediction that didn’t turn out.
It’s Also About the Future
Markets are overall expecting the European Central Bank (ECB) to be quite dovish, despite the recent uptick in inflation. That’s because consumer prices are expected to pop back up for a bit around the end of the year, and then go back down to target in early 2025. The thought is the ECB, facing a near-stagnant economy, won’t want to wait that long to ease. That means that the 25-bps option is expected to come along with a statement and a press conference leaving the door wide open to more easing at the next meeting. If that doesn’t happen, then the market could react as if the central bank in Europe became more hawkish.
There is a strong perception of future easing. Economists forecast 100 bps of cuts next year. Markets are even more dovish, pricing in 150 bps by the end of next year. That makes it more likely for the central bank to surprise to the upside than the downside, giving the Euro an upside risk. However, the bump might fade quickly as easing bias remains strong.
The Effects of the Context
Analysts seem to think that the ECB will likely ignore the political turmoil in Europe and the potential of tariffs next year when Trump takes over the White House again. But, that is likely to come up in the press conference. And the political uncertainty can’t be completely ignored, as the risk premium has driven up bond prices, affecting the currency.
With markets seeming to think that the ECB is now prioritizing economic growth over the last bit of high inflation, the focus could turn to the central bank’s economic projections. The ECB spent decades fighting a slow growth, slow inflation scenario, and it’s understandable that it would like to avoid returning to that. Markets might seize on whether or not the ECB expects the economy to pick up earlier next year or not in order to price in the chances of future easing.
