By Daniela Sabin Hathorn, senior market analyst at Capital.com
We seem to have turned a page in the monetary policy handbook recently as markets are now trying their best to price in the first rate cut from major central banks. The continued drop in consumer prices has shaped expectations that there will be no more rate hikes within the developed economies, but when will the cutting begin?
In Europe, the Consumer Price Index (CPI) for the Eurozone dropped from 4.3% to 2.9% in October, a larger drop than markets were anticipating. Coming from a peak reading of 10.6% just a year ago the drop is significant, but is it enough to convince Lagarde and her team at the European Central Bank (ECB) that rates should be lowered in order to aid the economy through this period of transition?
Markets seem to think so. Market-implied pricing shows a 25% chance that rates will be cut 25bps in March 2024, with the first cut being fully priced in for the June meeting. Of course, a lot can change from here until then, with data being the most likely driver of implied pricing in the coming months.
Past Performance is not a reliable indicator of future results.
CPI expected to continue dropping but speed of decline likely to stall
This week we will see the first reading of the November CPI being released. Forecasts from a poll by Reuters are showing expectations of a marginal drop in headline CPI to 2.8%, and core CPI dropping from 4.2% to 3.9%. If so, the drop will likely feel lacklustre when compared to the previous month, but given how messy the disinflation process can be, a smaller increase than the previous month, no matter how small, is still a victory.
Meanwhile, ECB President Christine Lagarde was speaking to the Committee on Economic and Monetary Affairs of the European Parliament on Monday. There wasn’t much that hadn’t been said before, but she highlighted the fact that growth has started to stagnate in recent quarters and the jobs market is showing signs of softening. The latest reading showed GDP contracted by 0.1% in Q3. Lagarde also reiterated that despite the weakening of inflationary pressures, wage pressures remain elevated and the medium-term outlook for inflation is still surrounded by considerable uncertainty.
Past Performance is not a reliable indicator of future results.
Economists warn about cutting rates too soon.
The timing of the first rate cut is going to be key. In recent months, many economists have been voicing their concerns about cutting rates too early. Bundesbank President Joachim Nagel said in a speech two weeks ago that “it would be unwise to start cutting interest rates too soon. We must not loosen policy until we are absolutely certain of returning to price stability on a lasting basis.” Austria’s Robert Holzmann went as far as pinpointing a date, saying that the second quarter is simply too soon for a rate cut. He added that he was trying to communicate to markets that they should not believe that this is the end of the story on rate hikes.
The general consensus amongst policymakers seems to be that they would rather err on the side of caution and not loosen policy until they are absolutely certain of returning to price stability on a long-lasting basis.
EUR/USD technical analysis
EUR/USD continues to eke out the gains in recent sessions. That said, most of the momentum has come from the dollar side of the trade. The continued weakness in US data has led markets to believe the Fed will hike no further and will potentially need to start cutting rates soon. Regardless of how it turns out, the possibility of upcoming rate cuts has ended the dollar’s 3-month dominance in FX markets as yields adjust lower. The bias remains lower in USD which allows the bullish view for EUR/USD to continue in the short-term.
The Euro Zone CPI data may provide some opportunity for traders. It seems pretty hard at this point to determine direction based on the outcome of the data. On the one side, a drop in CPI is likely welcomed by EUR traders as it improves risk sentiment towards the state of the bloc’s economy. However, markets may be concerned about rates being cut too soon and therefore may be cautious if the drop in CPI is larger-than-expected. It’s likely that for EUR/USD the best outcome would be that the Fed cut rates before the ECB, or at least that markets continue to believe that that will be the case.
EUR/USD daily chart
Past Performance is not a reliable indicator of future results.
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