The euro has entered a downtrend against the US dollar since late September, following a peak at a 15-month high. While some analysts anticipate a potential short-term rebound, they also indicate that the euro’s overall weakness may continue for the time being.
As the European Central Bank (ECB) prepares to announce its interest rate decision, the euro’s decline against the US dollar continues. The EUR/USD pair has experienced a 3% drop from its September high of over 1.12, fluctuating around the mid-1.18 range during Thursday’s Asian session.
Market analysts generally predict that the ECB will implement a further 0.25% reduction in interest rates, lowering the deposit rate to 3.25%. If the ECB adopts a more hawkish stance than currently expected, a rebound in the euro could occur, as the markets are already pricing in the anticipated third rate cut.
What If the ECB Surprises with a Hawkish Tone?
Contrary to general expectations, the ECB’s stance may not be as dovish as the market assumes. A hawkish surprise could result in a significant rebound for the euro and an uptick in eurozone government bond yields. While market participants are optimistic about a quick series of rate cuts, the central bank is likely to take a more cautious, measured approach in its easing policy.
According to preliminary data from Eurostat, eurozone inflation cooled to a below-target level of 1.8% year-on-year in September. The final data, expected to align with the initial estimates, is unlikely to alter the narrative of a 0.25% rate cut unless a revision upwards in inflation is made.
Christine Lagarde, ECB President, addressed the European Parliament’s Committee on Economic and Monetary Affairs, stating, “As we look forward, inflation may experience a temporary rise in the fourth quarter due to the previous steep declines in energy prices dropping out of the annual rates. However, the latest developments bolster our confidence that inflation will return to target timely. We will take this into account at our upcoming monetary policy meeting in October,” hinting at the likelihood of a rate cut in October.
Despite this, she emphasized that the ECB’s approach will be “data-dependent,” asserting, “Policy rates will remain sufficiently restrictive as long as necessary to meet our objectives. We’re not committing to a specific rate path.”
Carsten Brzeski, Global Head of Macro at ING Research, expressed that “a hawkish surprise cannot be completely dismissed.” He noted, “The decision to cut rates will likely be more contentious than the markets currently perceive.”
Long-Term Outlook for the Euro’s Weakness
The value of a currency is shaped by various fundamental and market-driven elements. Key factors include central bank interest rates, inflation levels, economic momentum, and political stability. At present, all these fundamentals contribute to the euro’s decline due to lackluster inflation, economic stagnation, political uncertainty, and the ECB’s easing trajectory.
Michael McCarthy, Market Strategist and Chief Commercial Officer at Moomoo Financial Inc., shared with Euronews, “While Lagarde will likely stress a ‘meeting by meeting’ approach, declining growth and inflation data suggest that this statement may be overlooked. I anticipate a slight uptick in the euro after the announcement, but the currency is expected to resume its medium-term downtrend, retreating from its two-and-a-half-year highs.”
He also pointed out that the recent downward pressure on the euro is exacerbated by the strength of the US dollar, as markets have moved away from the “most dovish scenarios” regarding the US economy.
The Federal Reserve (Fed) initiated its easing cycle with a notable 0.5% rate cut in September, which initially led to a decline in the US dollar. However, the dollar has rebounded this month, buoyed by a sequence of robust economic data from the US, particularly in the labor market. Money markets are now anticipating a 0.25% cut from the Fed in November, a shift from the previously expected 0.5%. The differing policy expectations between the two central banks have further added to the euro’s weakness against the US dollar.
Photo credit & article inspired by: Euronews
