The European Central Bank May Cut Interest Rates Again
The European Central Bank May Cut Interest Rates Again
By:Ilya Spivak
A dovish ECB could send the euro chasing the British pound lower against the U.S. dollar
- Soft U.K. CPI data is eating away at European currencies’ resilience.
- All eyes are turning to the ECB policy decision, with another cut expected.
- The euro may fall against the U.S. dollar as yield differentials widen.
European currencies are holding up relatively well against a resurgent U.S. dollar—at least better than their peers in the Asia Pacific region. The first crack in their defenses came as soft U.K. consumer price index (CPI) inflation data beckoned a dovish rethink of Bank of England (BOE) interest rate cut expectations. That pushed the British pound lower, as expected.
The euro faces its next potential setback as the European Central Bank (ECB) prepares to issue a monetary policy announcement. President Christine Lagarde and company are narrowly expected to cut the target deposit interest rate by 25 basis points (bps) to 3.25%. Another such move is priced in with better-than-even odds for December.
The economies of the U.S. and the Eurozone are parting ways
Taken together, the markets have discounted 44bps in stimulus before year-end. That amounts to a cumulative 88% probability that both rate cuts will occur. Next year is expected to bring still move easing. Benchmark euro short-term rate (ESTR) interest rate futures are implying 103bps in additional stimulus.
At 147bps in all, this is narrowly more dovish than the 133bps that markets expect from the Federal Reserve over the same period. Meanwhile, the economies of the Eurozone and the U.S. are diverging. The former shrank in September while the latter kept growing at a healthy clip, according to S&P Global purchasing managers’ index (PMI) data.
The latest Eurozone CPI data showed inflation fell to an unexpectedly low 1.8% year-on-year in September. Moreover, sticky prices are most acute in the hospitality sector, which depends on discretionary spending and ought to be especially sensitive to a downturn in the economic cycle.
The euro may fall further against the U.S. dollar
On balance, all this suggests ECB officials might signal a growing appetite for policy support as economic performance flounders. A follow-on repricing of the expected rate cut path to a more dovish setting may expand the implied policy gap between the U.S. and the currency bloc. That might send the euro lower against the greenback.
Ilya Spivak, tastylive head of global macro, has 15 years of experience in trading strategy, and he specializes in identifying thematic moves in currencies, commodities, interest rates and equities. He hosts Macro Money and co-hosts Overtime, Monday-Thursday. @Ilyaspivak
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