ECB Split Ahead of Rate Meeting

As the ECB looks to be near the finish line of its push to end the highest inflation since the creation of the shared economy, there is considerable uncertainty about whether there will be a final rate hike.

Balancing on the Knife's Edge

Investors are almost evenly split on whether the ECB will go through with a rate hike when it meets on Thursday. Money markets price in a 45% chance of a quarter-point hike, which was higher than the previous day, as traders adjust to higher hawkish risks. Separately, it was reported that even the committee members still determine how the vote will go. Or if the bank will opt for non-traditional measures to bring down inflation without raising the risk of pushing the shared economy into a recession.

Analysts say this is the hardest-to-call decision since the start of the hiking cycle, pointing to the bank balancing high inflation with slow growth prospects. This year, the European Commission recently downgraded its outlook for the euro area economy, forecasting Germany to fall back into recession and register negative growth. Analysts speculate this might be the last chance that hawks have to push through a rate hike before the autumn downturn in the market and economy might mean that further tightening would be off the table.

A Divided House

ECB President Christine Lagarde, for the first time in over a year, did not provide any guidance for what to expect at the meeting, stating that the decision will be data-dependent. But the data needs clarity, with GDP revised down to 0.1% growth in the second quarter. The core inflation rate in August was still at 5.3%, matching the rate from May, after taking an excursion up to 5.5% in the intervening months. The northern countries have expressed the need to take more action to bring down inflation, while the periphery has discussed being near the end of the rate hiking cycle.

On the other hand, the markets see the possibility of a pause and then a hike, with futures contracts pricing in an 80% chance that rates will be at least 25bps higher by the end of the year. This mirrors expectations for the Fed, with the market expecting the two largest central banks in the world to mirror each other for the rest of the year. That would mean the rate differential would remain the same and leave moves in the EURUSD down to future economic performance. With much higher inflation in the EU, real rates are at a distinct disadvantage against US rates. While economists fret over the future of the Eurozone and the leaders cut economic prospects, for the US, investors are becoming increasingly convinced that there will be a soft landing. Those factors combined could keep the pressure on the Euro in the medium term - unless the hawks win out on Thursday and push rates higher, emphasising inflation over growth.

Eurodollar in Bearish Flag Short-term

The Eurodollar rate has been in a freefall since July’s top of $1.1270 but still hasn’t reached the bottom of $1.0635 to at least assume a potential range. The short-term upside formation, however, resembles a bearish flag, with the chances of additional slides reasonably split.

If bulls attempt a takeover but fail to gain traction past $1.077 or $1.087, sliding under $1.07 may raise speculation for drops below May’s support and in the $1.05 zone. Otherwise, $1.0947 may offer an upward leg to $1.1066 and, eventually, the market top, implying a weak attempt at $1.0635.

Source: SpreadEx / EURUSD

Key Takeaways

The ECB faces uncertainty as it nears the decision to proceed with a final rate hike to address high inflation levels. Investors are divided, some expecting a hike while others anticipating a pause. The ECB must balance inflation concerns with slow growth prospects and navigate the potential risks to the shared economy. The outcome of the decision will have implications for the Eurodollar rate, which has been in a downward trend but shows potential for further declines. Overall, the ECB's decision and market dynamics will significantly shape the future economic landscape.