Tomorrow may result in slightly more excitement brought about by the European central banking institution. The European Central Bank (ECB) is likely to decide on another interest rate cut. The market at the moment assumes that such a scenario is the most probable. Overnight Index Swap (OIS) tools have almost fully priced in a decrease of 25 basis points. However, if the board decided to “pause”, then the euro could gain considerably. On the other hand, whether the common currency can continue to weaken, even though the October cut is already “priced in”, is a point of debate.
There is a high chance that the cost of money in the euro area will decrease once again. This perspective is shared by the markets. This narrative is re-enforced by recent decreases in Purchasing Managers’ Index (PMI) and also the inflation rate in September. Additional suggestions came from Christine Lagarde, who during her appearance in the European Parliament made it clear that recent events have strengthened the Council’s conviction in a likely return to the inflation growth dynamics within the ECB’s target in due time. She stated this will be taken into consideration. It is difficult to interpret this message differently than as a signal of another cut. Rate cuts are also suggested by members categorized as “hawks”. This refers to recent statements from Martins Kazaks, who agreed with the market valuation.
The current phase of reductions may last until the end of this year. However, the market increasingly contemplates what the 2025 cycle would look like. There is a risk that at the end of this quarter we may see a boost in inflation, due to special factors that lowered the CPI in August and September no longer being in operation. Furthermore, core inflation could be stubborn. Wages are still rising, which will put pressure on service prices. Over time, money’s cost in the eurozone will approach the neutral interest rate. The Board of Governors may see increasing voices for a halt in the cycle. The ECB currently sees the neutral interest rate between 2 and 2.5 percent. Lagarde will need to communicate to the market that the pace of changes to the monetary policy parameters will decrease in the coming year. Decisions are likely to be taken only at meetings when the latest macro projections are available.
In the medium term, the euro should remain weak for two reasons: the “dovish” attitude of the ECB and the economy’s weakness. The EUR/USD rate going towards 1.08 – 1.06 over the next few weeks/ quarters is entirely realistic. In the long-term horizon, a lot will depend on the pace of ECB interest rate cuts in 2025. If the economy starts showing signs of recovering (indicating a cyclical bottom is already past us), the market may again buy euros in anticipation that the cost of money will ultimately not fall as low as it was persistently maintained for many years.
Written by Łukasz Zembik, Oanda TMS Brokers.
Source: https://ceo.com.pl/kolejna-obnizka-stop-procentowych-ebc-coraz-blizej-rynek-przygotowany-na-decyzje-22502
