Euro Declines as ECB Set for Rate Cut
The EUR/USD currency pair fell below the 1.09 handle on Tuesday, 15 October, following a poor trading session on Monday ahead of the Europe Central Bank’s (ECB) interest rate decision on Thursday this week. As the bank eyes another interest rate cut, a stronger dollar on the back of expectations of less aggressive interest rate cuts by the Federal Reserve supported this trend.
Euro traded lower against the British Pound (EUR/GBP) as well, despite recent speculation that the Bank of England (BOE) might take a more aggressive path to interest rate cuts.
Let's explore the reasons behind the weaker euro.
Markets Price in ECB Rate Cut
The ECB is set to deliver its third interest rate cut this year on Thursday and, according to recent market data, its fourth and final cut to 3% in December. The decision comes as the Europe Area (EA) grapples with lower inflation than the central bank’s target of 2% at 1.8% as of the last CPI report in September.
Policymakers have shifted their stance to more dovish after President Christine Lagarde expressed confidence that “inflation will return to target in a timely manner”. This contrasted with the “gradual approach” the ECB head displayed before. (Source: CNCB)
While core inflation remained above target, it also slowed down in September, falling to a 3-year low. Moreover, despite unemployment reportedly being low by European standards, the current 6% figure is relatively high compared to major economies.
The UK’s unemployment rate, for context, fell to 4% according to UK’s labour data posted earlier on Tuesday, below the expected 4.1%. Employment for the three months to August hit a record high of 373,000 to 33.37 million as the economic inactivity rate fell to 21.8%. However, inflation in the UK has also stabilised to 2.2%, whereas in the EU, the ECB is expected to cut to support economic growth amid signs of cooling inflation.
Growth Concerns Remain in the Eurozone
The ECB meeting minutes in September showed that while the Central Bank was comfortable with a gradual pace of interest rate cuts at the time, concerns about disappointing growth were increasing as the then-new data pointed to a downward GDP revision.
Some ECB members favoured an interest rate cut at the October meeting due to weak sentiment indicators and falling headline inflation. However, others preferred to push it back to December, which includes staff projections, to allow changes in growth and inflation to transpire in the economy. (Source: Think.Ing).
For context, the Eurozone’s GDP growth for Q2 was revised down to 0.2% in September ahead of the last meeting, with Germany falling into recession. Analysts expect Europe’s largest economy to also contract in Q3 as the country experiences economic weakness from being cut from Russia’s energy supplies, issues in its automotive industry and poor export demand to China as the country faces uncertainty in achieving its 5% GDP growth target and whether recent talks around stimulus will suffice in sputtering its depressed economy.
On the other hand, the UK economy grew by 0.2% in August after stagnating for two months and facing a minor recession at the start of 2024 as Finance Minister Rachel Reeves prepares to deliver her growth-focused Autumn Budget. Still, markets expect the BOE to cut interest rates only for the second time this year, with a 93% probability, in its November 7 meeting to help stimulate the economy further at a better pace.
Projections for ECB and BOE
Analysts at RBC (RY) expect both the ECB and BOE to cut interest rates at each meeting through next May as inflation pressures continue to abate. With Europe’s inflation undershooting target and the BOE stable at 2.2%, the UK’s inflation figures on Wednesday may be important for short-term direction.
Notably, UK CPI inflation is expected to drop below the target to 1.9% from 2.2% and core to 3.4% from 3.6%. As Governor Andrew Bailey indicated recently, meeting estimates may increase the chances of more aggressive BOE cuts. However, attention will be focused on Services CPI and whether it falls to consensus estimates of 5.2% year-on-year. Services were partially responsible for the UK’s GDP growth in Q2, a sector in which the UK had a significant £40 billion surplus.
If Services CPI and headline inflation in the UK come in as expected, EUR/GBP could consolidate above the round 0.8300 support or glue near 0.8350. However, a further drop would increase the chances of a more aggressive BOE and push the pair towards recent highs at 0.8430 ahead of the UK Budget on 30 October. (Source: FXStreet)
Conclusion
As the ECB prepares for its third rate cut of the year, the Euro continues to weaken against both the US Dollar and the British Pound, reflecting the ongoing economic challenges within the Eurozone, including subdued inflation and sluggish growth.
Meanwhile, the UK economy shows signs of stability in inflation and growth, though the BOE is also expected to proceed with its second cut in November to stimulate better-than-Europe growth.
The upcoming inflation data in the UK and Europe’s ECB decision will play a crucial role in shaping short-term movements in EUR/GBP and how the two central banks will forge ahead.