Fed, ECB Interest Rates to Further Diverge

The two most influential central banks are expected to adopt divergent monetary policy stances this week, with the Fed holding and the ECB pursuing a more accommodative approach aimed at stimulating economic activity.​

Interest Rates on Hold in the US

The Fed is expected to keep its interest rates on hold at its upcoming meeting on Wednesday. Market participants see a 98% likelihood that rates will remain unchanged and the Fed will not signal another rate cut in the near future. In fact, markets do not expect another rate cut until June, with a total of two rate cuts projected for the entire year. This represents an enormous slowdown from the latter part of last year when the Fed cut rates by 100 basis points over the course of three meetings. Although there is a consensus on a rate hold among economists, some are slightly more optimistic about the timing of the next rate cut, with a majority forecasting easing starting in March.

Despite the change in course towards holding rather than cutting rates, the expectation is that the language in the policy statement and during the presser will not see significant modifications. It is worth noting that there is a slight change in the composition of the FOMC voting members as part of the usual annual rotation, which has shifted the tone to slightly more hawkish. Given the strong consensus on the rate hold, markets are likely seeking insight into the timing of the next rate cut. If the majority of economists are correct in their prediction for March, then the market would likely have to adjust and weaken the US dollar.​

ECB Rate Cut Expected This Week

On the other hand, the ECB is widely expected to reduce its benchmark rates by a further 25 basis points. Feared Trump tariffs have yet to materialise and inflation is trending towards the target while the economy is struggling to gain momentum, adding to uncertainty about the region's outlook. As a result, traders hoping for a definitive answer about future rate cuts during President Christine Lagarde's press conference might get disappointed. The expected cut, however, would widen the growing gap between interest rates in the US and Europe, which has contributed to the downward trend of the EURUSD rate.

Economists believe that easing will continue, even if the ECB itself tries to avoid stating this in an effort to prevent inflation from escalating as they normalise monetary policy. A couple of weeks ago, before the pre-rate decision blackout period, ECB Chief Economist Philip Lane said that further policy easing is possible but stressed that the bank is seeking to balance concerns over a potential recession against concerns that inflation might rise again. The CPI growth rate within the shared economy is still not back to the target, even though Lagarde herself has repeatedly stated that she believes it is on track to reach 2% by the end of the year. Economists had primarily cited the threat of tariffs as a reason for more easing being needed, and with the White House keeping trade duties in reserve, the ECB might take pains to maintain a vague stance about future rate moves.​

EURUSD Leaves Behind iH&S

On the technical front, the EURUSD pair has formed a weak inverse head-and-shoulders (H&S) pattern and could accelerate towards 1.0632. The measured move target from the neckline resistance indicates short-term resistance at 1.0550, while support below the 1.0437 swing sits at 1.035.

Source: SpreadEx / EURUSD

Key Takeaways

The Fed is expected to keep its interest rates unchanged during its upcoming meeting, while the ECB is widely anticipated to proceed with a 25-basis-point rate cut. Market participants will want to scrutinise policy statements and post-event pressers for insights into future rate moves, which could justify or invalidate the recent price action in EURUSD. The pair has formed a bullish inverse head-and-shoulders pattern, suggesting potential for a reversal if key resistance at 1.0632 is breached.