The European Central Bank (ECB) will have its first monetary policy meeting of the year on Thursday, but little is to be expected from European policymakers. The Main Refinancing Operations Rate will likely be maintained unchanged at 4.50%, and the Deposit Facility Rate at 4%. If something is, the central bank will continue “tightening” through the reduction of reinvestments in the Pandemic Emergency Purchase Programme (PEPP).
Indeed, the ECB is pivoting and rate cuts are on the table for 2024. Still, central bankers need further evidence underlying inflation is under control before taking such a bold step.
Back in December, the Governing Council decided to keep the three key ECB interest rates unchanged, acknowledging inflation dropped in the previous months while estimating price pressures are likely to “pick up again temporarily in the near term.”
The ECB is widely anticipated to repeat the December decision of leaving the three key interest rates unchanged. Back then, the Governing Council expected headline inflation to average 5.4% in 2023, 2.7% in 2024, 2.1% in 2025 and 1.9% in 2026. Regarding economic growth, the staff projected it picking up from an average of 0.6% for 2023 to 0.8% for 2024, and to 1.5% for both 2025 and 2026. The general message was the “higher for longer” that introduced the Fed, as policymakers noted they intend to set policy rates at sufficiently restrictive levels for as long as necessary.
Meanwhile, inflation in the Eurozone has ticked higher. The Harmonized Index of Consumer Prices (HICP) rose to 2.9% YoY in December, slightly better than the 3% expected but higher than the previous 2.4%. The core annual HICP printed at 3.4% YoY, easing from 3.6% in November. Core inflation is pretty much doubling the central bank’s goal of around 2%.
The minutes of the ECB's December meeting showed policymakers did not discuss rate cuts. In fact, President Christine Lagarde pushed back against expectations on rate cuts in the press conference that followed the December announcement. "We should absolutely not lower our guard," Lagarde said.
However, things are not that clear ahead of the first 2024 decision. Over the last month, European policymakers have been commenting on the possibility and timing of rate cuts, forcing President Lagarde to clarify her stance at the World Economic Forum in Davos, Switzerland. Once again, she said that the economic risk of cutting rates too quickly was greater than the risk of leaving them too high, adding aggressive rate-cut bets does not help the ECB. Finally, she ended up hinting at a potential cut for the next summer, somehow giving in to the market’s pressures.
With that in mind, the focus will be on whether the central bank introduces rate cuts to the discussion in this January meeting and any clue policymakers could provide on the timing. The most likely scenario, however, would be President Christine Lagarde repeating the battle against inflation is not yet done, emphasizing the need to maintain rates higher for longer at the risk of price pressures resuming the advance. It is still to be seen, however, if hawkish words from the central bank’s head could positively impact the Euro, as bets against it are way too high.
A dovish shift in Lagarde’s tone will be partially surprising and may put the Euro on a steep bearish path.
As a note of colour, Reuters published on Wednesday a survey from the International and European Public Services Organisation (IPSO). The survey shows a majority of ECB employees think Christine Lagarde is not the right person to lead the institution, and that her performance is worse than that of her predecessors.
Reuters also reported that “An ECB spokesperson said the survey was flawed and included topics for which the Executive Board or Governing Council rather than solely the President is responsible and that are not within IPSO's remit.”
The EUR/USD pair trades around the 1.0900 figure ahead of the event, lacking directional strength for a second consecutive week. Valeria Bednarik, FXStreet Chief Analyst, notes: “Financial markets are in wait-and-see mode ahead of central banks’ decisions. It may be the turn of the ECB, but it is worth reminding the Federal Reserve (Fed) will announce its decision next week. Investors need fresh clues from policymakers to place firmer bets.”
Regarding the EUR/USD pair’s technical perspective, Bednarik adds: “The daily chart for EUR/USD suggest bears hold the grip, but eased the pressure, as alongside the ECB announcement, the United States (US) will publish the preliminary estimate of the Q4 Gross Domestic Product (GDP). Nevertheless, the risk skews to the downside, with the pair posting lower lows on a weekly basis since the year started. In the mentioned time frame, the pair has been meeting buyers around a flat 200 Simple Moving Average (SMA) at 1.0845, the level to pierce ahead of a steeper slide. At the same time, technical indicators remain within negative levels, with no signs of particular directional interest.”
Additionally, Bednarik notes: “Buyers would need to recover the 1.1000 threshold to have a chance of beating bears. In such a scenario, and if the pair is able to sustain gains after the dust settles, the rally could continue initially towards the 1.1040-1.1060 ahead, while beyond the latter, the pair could extend gains up to the 1.1120 price zone.”
The European Central Bank (ECB) in Frankfurt, Germany, is the reserve bank for the Eurozone. The ECB sets interest rates and manages monetary policy for the region.
The ECB primary mandate is to maintain price stability, which means keeping inflation at around 2%. Its primary tool for achieving this is by raising or lowering interest rates. Relatively high interest rates will usually result in a stronger Euro and vice versa.
The ECB Governing Council makes monetary policy decisions at meetings held eight times a year. Decisions are made by heads of the Eurozone national banks and six permanent members, including the President of the ECB, Christine Lagarde.
In extreme situations, the European Central Bank can enact a policy tool called Quantitative Easing. QE is the process by which the ECB prints Euros and uses them to buy assets – usually government or corporate bonds – from banks and other financial institutions. QE usually results in a weaker Euro.
QE is a last resort when simply lowering interest rates is unlikely to achieve the objective of price stability. The ECB used it during the Great Financial Crisis in 2009-11, in 2015 when inflation remained stubbornly low, as well as during the covid pandemic.
Quantitative tightening (QT) is the reverse of QE. It is undertaken after QE when an economic recovery is underway and inflation starts rising. Whilst in QE the European Central Bank (ECB) purchases government and corporate bonds from financial institutions to provide them with liquidity, in QT the ECB stops buying more bonds, and stops reinvesting the principal maturing on the bonds it already holds. It is usually positive (or bullish) for the Euro.
One of the European Central Bank's three key interest rates, the rate on the deposit facility, is the rate at which banks earn interest when they deposit funds with the ECB. It is announced by the European Central Bank at each of its eight scheduled annual meetings.Read more.
Next release: 01/25/2024 13:15:00 GMT
Source: European Central Bank