We expect the Governing Council to cut rates by 25 basis points on Thursday, but a larger move cannot be entirely ruled out. If this happens, the euro would face a sell-off. In the case of a standard cut, the euro’s valuation will depend on the ECB’s statements and its projections for GDP and inflation. Significant downward revisions, especially for core inflation, would be a negative signal for the currency.
Key Points:
- The ECB is likely to cut rates by 25 basis points.
- Lagarde will highlight risks to growth.
- The Council may hint at discussions about a 50 basis point cut.
- Revised macroeconomic projections will be crucial.
- We expect downward revisions for GDP and inflation.
- The euro could weaken on the possibility of a jumbo cut in the near future.
After the last meeting in October, the ECB made it clear that it remains in a monetary policy easing cycle. As was the case then, discussions before the upcoming meeting focus on the size of the cut: a standard 25 basis points or a larger 50 basis points. As expected, policymakers opted for the first option, but during the press conference, President Christine Lagarde emphasized concerns about inflation prospects. She also expressed disappointment with economic activity, reiterating that the balance of risks to growth in the eurozone is tilted to the downside.
Political Uncertainty Among the Risks to Economic Growth
Since the October meeting, the situation has undoubtedly worsened. Locally, political uncertainty in the two largest economies of the bloc has resurfaced. The French government, led by Michel Barnier, collapsed after failing to pass the 2025 budget, causing a sharp increase in yields on French government bonds. Additionally, due to the collapse of the ruling coalition, snap elections will take place in Germany in February.
The economic outlook is further clouded by Donald Trump’s victory in the U.S. presidential elections. Given his protectionist approach, we expect eurozone growth to be constrained over the next year.
These risks are reflected—at least partially—in recent economic data. The November PMI indicators for business activity were disappointing, with the composite index falling to a 10-month low of 48.3 points, below the critical 50-point threshold. Inflation momentum also seems to be wavering. In November, both headline and core inflation measures in the eurozone were negative month-over-month, with core prices falling by 0.6% m/m—the largest drop since January.
Potential Downward Revision for GDP and Inflation
The revised projections will be the markets’ primary focus this month. Given the low values recorded in the November inflation report and the potential decline in consumer and business confidence due to recent political turmoil, we expect a slight downward revision of price forecasts for 2025. We also believe the growth projection for next year (currently 1.3% from September) will be lowered. Modest changes are unlikely to significantly alter market expectations for rate cuts. However, a surprisingly large downward revision of inflation forecasts could convince the swap markets that a 50 basis point cut is imminent at the next meetings.
Markets Expect a Jumbo Cut in the Coming Months
The above factors give the ECB’s dovish members additional arguments for a 50 basis point rate cut this month, and it seems that policymakers like Lane and Villeroy are considering this possibility. It cannot be entirely ruled out. If a larger cut does not materialize, Lagarde might signal during the press conference that a jumbo cut was discussed. This could increase the likelihood of a larger move in January or March, which is currently the market’s base scenario.
Recently, markets have scaled back expectations for a 50 basis point cut this week (currently pricing in 29 basis points). A jumbo cut would undoubtedly trigger a strong sell-off of the euro. In the case of a standard cut, we do not expect an immediate euro reaction; it will depend heavily on the ECB’s statements and revised projections.
Euro May Suffer from Forecast Revisions
We believe that hawks and doves within the Council will reach a compromise this week. Rates will be cut by 25 basis points, with statements emphasizing that cuts will continue until neutral levels are reached. The balance of risks for the euro before the meeting leans downward. In our view, Lagarde will signal further weakness in eurozone growth and hint that discussions on a 50 basis point cut took place. Inflation projections will likely be revised downward, and the scale of these changes could determine the euro’s fate—significant downward revisions, particularly for core inflation, would be a notably negative signal for the euro.
The ECB’s policy decision will be announced on Thursday (December 12) at 2:15 PM, with President Lagarde’s press conference starting 30 minutes later.
Authors: Matthew Ryan, CFA – Head of Market Analysis, Ebury
Source: https://ceo.com.pl/decyzja-ebc-obnizka-stop-pewna-ale-rynek-obawia-sie-wiekszego-ruchu-99496
