ECB on Track for June Rate Cut

Markets are eyeing the flash inflation figures from Europe tomorrow to confirm expectations that the ECB will be the first major central bank to start easing this cycle.

A Bump in the ECB's Easing Path

Euro area inflation has been consistently falling for several months, indicating that the ECB will likely cut interest rates at its June meeting. Surely, inflation does not need to reach the bank's 2% target for action. Policymakers may act to ease monetary policy if inflation trends in the desired downward direction. With the eurozone's economic growth sluggish, the ECB views current interest rates as too restrictive and aims to lower them to a "neutral" level soon.

However, this trend may experience a slight wrinkle. April data may show a slight inflation increase to 2.5% year-over-year (YOY) from 2.4% prior, primarily due to rounding in forecasts. Higher fuel costs contributed temporarily, while March saw an unusual drop. More significantly, core inflation is projected to remain unchanged at 2.7% without volatile food and energy components. Overall, the data still fits the broader disinflationary trend, supporting the ECB's first rate cut in the easing cycle.

Enough to Alter the Course?

The relatively small change expected over the prior month increases the likelihood of missing or beating expectations, as a mere decimal could be the difference between matching expectations or rising compared to the prior month. However, a strong narrative has developed around a June rate cut, with economists unanimously agreeing that it is time to reduce rates. Waiting until the next meeting would mean holding off until late August since the ECB does not meet in July, making the rate cut timing more important for the markets.

The consensus implies that markets have moved past June and are focused on what will happen afterwards, as there is significant disagreement over whether the ECB will enact a second cut this year. While most economists support it, even dovish committee members, such as France's Francois Villeroy, are uncertain about the pace of a second cut after the first. The market's main reaction to the data could be the Euro seeing modest strength if inflation is higher than expected, as the market may discount a second rate cut.

The impact on EURUSD may be delayed as markets await upcoming US PCE data and what that means for expectations regarding the Fed's interest rate path. For now, markets are pricing inflation on a declining trend that would put the ECB in the lead when it comes to easing monetary policy, weighing on the Euro versus the US dollar.

EURUSD in Potential Inverse H&S

The EURUSD pair failed to rise past the 1.0895 handle and instead reversed under the 1.0805 short-term swing, paving the way for a potential drop to 1.0723. If this holds as support, an inverse head-and-shoulders (H&S) pattern may form, potentially sending prices soaring to 1.0980 and eventually 1.10. However, if the recent structure of the top forms a flag, the upward move may start earlier than expected when compared to the H&S speculation.

Source: SpreadEx EURUSD

Key Takeaways

Markets are eyeing upcoming flash euro area inflation figures to confirm expectations that the ECB will cut interest rates at its June meeting. While April data may show a slight increase in inflation, it is attributed to temporary factors, with core inflation projected to remain unchanged. The data still fits the broader disinflation trend, supporting the ECB's first rate cut in an easing cycle. A small change increases the likelihood of missing expectations, but the consensus is for a June rate cut, with disagreement over further cuts this year. The main market reaction may be modest Euro strength if inflation is higher than forecasted, as a second rate cut could be discounted.