Euro Fate Hangs in the Balance as ECB Weighs Options

The ECB is widely anticipated to cut its interest rates by 25 basis points on Thursday, but there is growing uncertainty about the subsequent course of action, with markets closely scrutinising signals.

Keep Cutting For Now

In a recent Reuters poll, all surveyed economists expect the ECB to cut rates for a second time this year and predict two additional rate cuts by mid-year. The focus now shifts to the timing and whether the accompanying statement from the central bank will convey a potential pause in easing after the subsequent meeting. Economists argue that the rationale for easing is running out with inflation nearing the 2% target and the threat of tariffs looming after US President Donald Trump proposed "reciprocal" tariffs on certain European goods.

During a pre-rate decision interview, ECB member and German representative Isabel Schnabel was the most explicit in calling for a debate on pausing rate cuts after the March meeting. While inflation has been rising through the winter due to higher energy costs, these costs have started declining in February. This could strengthen the case for front-loading rate cuts without providing specific guidance for a pause at the next meeting.

Agreeing On the Destination, Not the Journey

Analysts suggest that ECB members generally agree that interest rates need to be lowered to around 2% to reach a "neutral" level given the current circumstances, implying three more rate cuts (including the upcoming one). However, there is no clear consensus on the timing of the projected cuts. The ECB has cut back-to-back for several meetings now despite inflation rising, which supports the argument for a pause in April.

Meanwhile, the focus remains on the potential implications of tariffs. The Eurozone economy is fragile, with its largest economy, Germany, having witnessed two consecutive years of negative growth. It appears that lower interest rates, which typically support an economy, may not be as effective in mitigating the implications of a global trade war. Some analysts even warn that interest rates could rise during the year. In recent sessions, traders have been more risk-averse, selling stocks to buy bonds due to increasing concerns around tariffs, which weighed on the dollar and strengthened the Euro. If ECB President Christine Lagarde appears to side with the faction favouring a pause, the Euro could experience further upside. However, if the market does not fully price in a rate cut for the next meeting and the ECB strongly indicates continued easing, it could erase some recent gains in EURUSD.

EURUSD iH&S Breakout Potential

The pair might have formed an inverse head and shoulders pattern, suggesting a potential breakout above the neckline resistance of 1.063 and towards the measured-move projection of 1.10. However, a short-term reversal could invalidate the bullish pattern, opening the door to 1.053 and 1.036, with additional pressure exposing the low of 1.017. Conversely, resistance levels can be observed at 1.068 and 1.082 on the upside.

Source: SpreadEx / EURUSD

Key Takeaways

The ECB's rate decision and guidance will likely impact the Euro's trajectory, with the bank facing a delicate balancing act between addressing inflation concerns and supporting economic growth amidst global trade tensions. As the ECB is widely expected to cut rates by 25 basis points, the market reaction will likely hinge on the timing of the next rate cut and which direction the ECB President leans towards.