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ECB in the spotlight, Lagarde to temper rate cut expectations

INVESTINGECB in the spotlight, Lagarde to temper rate cut expectations

The upcoming week will bring the first decisions of central banks in 2024. The ECB, Bank of Canada, Bank of Japan, and the banks of Turkey and Norway will be deciding on interest rates. Investor attention is squarely on Lagarde. So far, investors have been expecting the Eurozone to make its first interest rate cuts soon, but the European institution will likely want to dampen these inflated expectations. Communication will be focused on wage development in the Eurozone, which will influence future inflation.

While ECB President Lagarde claimed at a press conference in mid-December that interest rate cuts were not even discussed at the monetary policy meeting, members of the ECB’s board openly mentioned the possibility during interviews at the economic summit in Davos. Lagarde herself suggested last Wednesday that interest rate cuts could be possible this year (in the summer). This newfound openness will likely be welcomed by investors who now see confirmation of their speculations about an impending series of interest rate cuts. The market is still pricing in a first interest rate cut in April followed by six additional cuts of 25 basis points each by the end of the year. The deposit rate would then be 2.5% by the end of the year.

Market expectations are rather exaggerated and have the opposite effect to that intended, in that they hinder restrictive monetary policy. Therefore, curbing these speculations will be a key task for the European bank this coming Thursday. Last week brought a slight shift in attitude, which reflected in a decline of the EUR/USD exchange rate, largely made up by the end-of-the-week.

For the ECB, the key factors at this point are wage growth dynamics and profit margins. The ECB’s Chief Economist recently emphasized that wage settlement data for Q1 will only be available at the end of April, meaning they can only be included in the bank’s June projection. From an inflation point of view, it is mainly crucial to what extent companies pass higher labor costs onto consumers.

The risk factor of potential higher energy prices and likely supply bottlenecks will certainly be highlighted. Recent events in the Middle East, particularly in the Red Sea, have led to a surge in freight rates for container shipping. This has directly affected higher oil prices and boosted inflation, making it more challenging to reach the ECB’s target.

The EUR/USD exchange rate has continued to decline in recent days. Tuesday was particularly volatile when Americans returned from a long weekend, and the dollar gained in value again. The chart reveals a pattern of correctional declines. This suggests a reaction. Another factor that suggests a potential change in trend is the double bottom formation on Wednesday and Thursday. A divergence of the stochastic oscillator from the chart of the instrument on a daily interval is also visible. On the other hand, the breakdown of the medium-term uptrend line suggests further declines. All signs point to a potentially decisive week for the EUR/USD exchange rate.

Author: Łukasz Zembik, Oanda TMS Brokers

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