Euro Predicted to Rise if Lagarde Rejects Optimistic Market Pricing

Above: File image of ECB President Christine Lagarde. Copyrights: Angela Morant/ European Central Bank.

Euro exchange rates can rise if the European Central Bank fails to verify market expectations for a generous path of interest rate cuts at today's meeting.

The ECB will almost certainly cut its deposit rate by a further 25bp to 3.50% as it responds to a slowing economy and releases new economic projections that will show it remains on track to bring inflation to the 2.0% target on a sustainable basis.

This won't bother euro exchange rates too much, and currency traders will be more interested in how the Bank and ECB President Christine Lagarde address the question of future rate cuts.

Lagarde is expected to avoid providing any forward guidance, i.e. avoiding a committment to a certain path. Instead, she should maintain a view that the nature of incoming data will determine what happens next.

"A gradual descent of interest rates at a pace of 25bp per quarter remains the most plausible future trajectory of monetary policy, which would probably strike the right balance between the different views within the Governing Council," says a note from UniCredit Bank.

However, markets see a more aggressive path of rate cuts: OIS pricing shows a 40% probability of another cut in October and a total of almost 60 basis points of cuts of easing by December. The rate is then anticipated to fall below 2% in the second half of next year.

UniCredit says indications by ECB President Lagarde that current market pricing is too stretched would trigger a rise in Eurozone bond yields as investors pare back expectations for rate cuts over the remainder of the year and into 2025. Rising bond yields would be expected to bolster the Euro against the Dollar, Pound and other G10 currencies.

"Scope for a euro bounce today," says Chris Turner, an analyst at ING Bank. "We think the central bank can pour a little cold water on the chances of a further rate cut in October."

But there are downside risks to the Euro, too. Lagarde will maintain a line that the data will determine whether the next rate cut comes in October or November, while the ECB will simultaneously release forecasts showing downgrades in growth and inflation projections. 

"This is precisely the crux of the matter for the euro," says Antje Praefcke, FX Analyst at Commerzbank. "Because if President Lagarde continues to emphasise the data dependency of the decision, the market could interpret this in combination with the adjustment of the economic forecast and the reference to the positive development in inflation to mean that the next interest rate hike could follow as early as October."

"In other words, the ECB could be quite reactive, at least on the dovish side of monetary policy. The euro could come under pressure and presumably dip further with every weaker price or economic figure in the coming weeks," she adds.

Those watching ECB headlines should also be wary of an unexpected headline that suggests the ECB has cut rates by a sizeable 60 basis points. Following a recent review, the ECB has decided it will close the gap between two of its most important interest rates from 50 basis points to just 15. This will create a headline cut of 60bp to the refi rate. The move is technical and expected, but we wonder if it will still cause some unintended volatility.