Euro Outlook Underpinned by ECB's Steady Hand

File image of ECB President Lagarde. Photo: © Angela Morant/ECB

The European Central Bank (ECB) cut interest rates and showed it was in no rush to deliver the next one, a stance analysts say can underpin the Euro.

Euro exchange rates were firm following the decision to cut the main deposit rate by 25 basis points to 3.5% and the release of new forecasts that included a lower growth profile but a slightly higher path for core inflation.

Following the decision, money market pricing shows investors see approximately 36 basis points of cuts to come over the remainder of 2024, which suggests markets see decent odds of more than one cut.

The risk is that the ECB's steady approach, which appears to favour a cut a quarter, will disappoint these expectations. Any repricing lower in rate cut expectations would be a fundamentally supportive development for the Euro.

"Were the FOMC to strike a relatively dovish note next Wednesday, this divergence could help to underpin EUR/USD over the medium-term," says Michael Brown, Senior Research Strategist at Pepperstone.

ECB President Christine Lagarde warned that inflation was expected to rise again in the latter part of this year, "partly because previous sharp falls in energy prices will drop out of the annual rates."

This strikes us as a relatively 'hawkish' assessment that would push back against any bets for an accelerated pace of easing. On balance, it adds to the sentiment that there are no downside dangers lurking for the Euro at today's event.

Every statement that leans in one direction is calibrated by one leaning in the other direction. With Lagarde's comments on headline inflation rising again, the ECB also said it expects "a rapid decline in core inflation" from 2.9% this year to 2.3% in 2025 and 2.0% in 2026.

What is certain is that more cuts are coming, even if at a pedestrian pace. The central bank will be unable to ignore its own revised projections that show growth is seen coming in weaker than previously forecast: "This is a slight downward revision (to GDP) compared with the June projections, mainly owing to a weaker contribution from domestic demand over the next few quarters," said the central bank.

"Changes to the Bank’s economic forecasts are also quite insignificant. The ECB will probably leave rates on hold until December before cutting again," says Andrew Kenningham, Chief Europe Economist at Capital Economics.

This is a safe ECB event that could ultimately draw consensus to the view that just one further cut is due in 2024. This is less than markets expect, and we would therefore brand this as a Euro-supportive update.