ECB Rate Cut Path Into Doubt Ahead of Meeting

As EU countries go to the polls, the ECB is broadly expected to cut rates while the focus turns to how much easing to expect this year.

The Changing Outlook

Economists and markets widely expect a 0.25% interest rate cut by the European Central Bank (ECB) at its Thursday meeting. However, recent employment data showing ongoing wage growth has introduced some uncertainty around the path of future rate cuts. While ECB members previously agreed on likely cutting rates in June, views of further easing after that differ. As such, the main focus of this meeting may not be the rate move itself but the accompanying statement and comments from ECB President Christine Lagarde regarding the projected path for interest rate cuts.

Markets forecast two rate cuts this year in June and October, while economists expect three. This divergence partly reflects the timing of recent surveys relative to the employment figures. After reviewing the data, markets shifted away from three rate cuts to two. However, most expect a pause following June. The ECB could create turmoil by strongly implying another immediate cut. But signalling no cuts for the remainder of the year would prove relatively hawkish, as that suggests maintaining rates at a still high level for a lengthy period.

Further Rate Cuts?

Market participants will carefully analyse the monetary policy statement to gauge its hawkishness or dovishness. The euro has recently strengthened, partly due to expectations of fewer interest rate rises by central banks. While the anticipated rate cut would still leave interest rates above inflation, it is viewed as remaining restrictive and could prompt more easing as economic growth in the Eurozone struggles to gain momentum.

The upcoming Parliament elections starting tomorrow add further complexity. The centre-right EPP group is expected to retain a majority, but recent national elections suggest that far-right parties may capture a larger share of votes. 2024 has not favoured incumbent administrations to date. There is also an ongoing leadership contest within the EU, with European Council President Claude Michel reportedly considering replacing European Commission President Ursula von der Leyen and considering former ECB chief Mario Draghi to succeed him instead. However, the final outcome of this week's parliamentary vote may impact any leadership changes, potentially causing uncertainty for the Euro in the interim.

EURUSD Retests Flag As Support

EURUSD may advance towards 1.1140 if it manages 1.0985 and 1.10 levels after rebounding from the flag trendline at 1.08. Conversely, a break below the regional support could see the pair slide to 1.07 without changing the current thesis. A fall below there may prolong the corrective pattern and potentially push the eurodollar as low as 1.05.

Source: SpreadEx / EURUSD

Key Takeaways

The ECB is expected to cut interest rates by 0.25% at its meeting this week. However, recent employment data showing ongoing wage growth has introduced some uncertainty around the extent of future rate cuts. Markets forecast two rate cuts this year in June and October, while economists expect three. Analysts will closely examine the policy statement for clues on the outlook for monetary policy and further easing as economic growth in the Eurozone remains lacklustre. The ECB will need to clearly communicate its projected path for interest rates to avoid creating turmoil in markets, especially since the upcoming EU Parliament elections and potential leadership changes may introduce some complexity.