File image of ECB President Lagarde. Photo: © Angela Morant/ECB
The Euro is riding out another rate cut at the European Central Bank (ECB) that didn't prove as 'dovish' as some had expected.
The Pound to Euro exchange rate is lower on the day and on the cusp of 1.21, disappointing euro buyers who hoped the ECB might have prompted another leg of weakness in the single currency.
The ECB reduced the three key ECB interest rates by 25 basis points, but the market did price the chance of a more forceful 50bp cut. The erasure of this market pricing will automatically assist Eurozone bond yields and the Euro.
"It comes as an immediate relief to the euro, with forecasters split almost 50-50 between a larger 50bps cut and a 25bps move ahead of the meeting," says Harry Woolman, Analyst at Validus Risk Management.
Most importantly, the ECB decision didn't indicate any 'dovish' shift in stance, i.e. one that guided us towards an accelerated pace of rate cuts in 2025.
The market already expects the ECB to cut further than other central banks, such as the Federal Reserve and Bank of England.
But, the ECB didn't see a reason to further these expectations. Specifically, the ECB's Governing Council avoided offering forward guidance by committing to further rate cuts.
It said it would remain responsive to the data and committed to "follow a data-dependent and meeting-by-meeting approach to determining the appropriate monetary policy."
"The Governing Council is not pre-committing to a particular rate path," it added. An effective copy-and-paste statement will shore up Eurozone bond yields and the Euro into year-end.
In addition, there was nothing alarming in the new projections issued by the ECB's economists, which are a key messaging tool in that they signal where future policy should target.
The ECB said most measures of underlying inflation suggest that inflation will settle at around the Governing Council’s 2% medium-term target on a sustained basis.
The ECB's forecasts now see headline inflation averaging 2.4% in 2024, 2.1% in 2025, 1.9% in 2026 and 2.1% in 2027. This is from the September forecasts of 2.5%, 2.2% and 1.9%, respectively.
"The ECB is holding its course," says Dr. Thomas Gitzel, Chief Economist at VP Bank. "Policymakers have recently been confronted with a renewed rise in inflation rates. However, this comes as no surprise. So the ECB is relaxed about the somewhat higher price pressure in the short term. The decisive factor is that the medium-term inflation outlook remains unchanged."
The ECB will want to cut again as it now anticipates a slower economic recovery than in its September projections, with growth at 0.7% in 2024, 1.1% in 2025, 1.4% in 2026 and 1.3% in 2027. This is down from the previous estimate for 0.8%, 1.3% and 1.5%.
Regarding FX market action, the Euro came under pressure in the run-up to the ECB decision, confirming market participants were front-running the decision to cut interest rates; we saw GBP/EUR hit a new 2024 high on Wednesday.
But the momentum in this trade might fade from here and could even reverse somewhat, as participants 'sell the rumour, buy the fact'.
Lagarde Spurs Euro Onwards
In the post-decision press conference, ECB President Christine Lagarde reiterated that the battle against inflation had not been won.
This assessment gave the Euro a leg up.
She noted services inflation is still too high at 4.2%. Lagarde says wages must cool further, alongside company profits, to ensure inflation is returned to a consistently lower level.
Despite this, Lagarde reaffirmed expectations that rate cuts might be coming, even if not as many as the market might have expected at the start of the day.
"The direction of travel is currently very clear," she said.