European Central Bank Preview: Another hold expected as focus shifts to timeline of interest-rate cuts

• The European Central Bank is expected to maintain its monetary policy unchanged. 
• ECB President Christine Lagarde hinted at summer as the time to pivot.
• EUR/USD should gain bearish traction once below the 1.0845 support area. 

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.”

European Central Bank interest rate decision: What to know in markets on Thursday

• Major central banks have held rates steady in the last quarter of 2023, as the risks of an economic setback weighed more than inflationary pressures. 
• The United States (US) Federal Reserve (Fed) foresees three rate cuts throughout 2024, although FOMC members retain a certain dose of caution. 
• EUR/USD peaked at 1.1139 by the end of December, entering a selling spiral afterwards and now trading below the 1.0900 mark. 
• Alongside the ECB’s announcement, the United States will release the preliminary estimate of the Q4 Gross Domestic Product (GDP). The economy is expected to have grown at an annualized pace of 2% in the three months to December, down from 4.9% in Q3. 
• Wall Street posted record highs this week, as investors hope the Fed will start sooner rather than later trimming interest rates. The odds for a March cut decreased lately, but speculative interest still believes rates will go down in 2024.
• The ECB’s January Bank Lending Survey (BLS) showed a tightening of credit standards amid persistent risk perceptions.
• Consumer Confidence in the Eurozone declined to -16.1 in January from -15, in December. 
• The  January preliminary HCOB/S&P Global Producer Manager Indexes (PMIs) indicated that business activity in the Eurozone fell at the slowest rate in six months, albeit with downturns persisting in both manufacturing and service sectors. Contraction readings are widespread throughout the sectors and major economies. 

What to expect from the ECB meeting and how could it impact EUR/USD?

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.”