Sept. 2024 ECB Rate Decision: What to Expect

The EUR/USD (EUR/USD) currency pair declined  on Tuesday 10 September, weighed down by falling German inflation data ahead of Thursday’s European Central Bank (ECB) interest rate decision. Interestingly, the Harmonised Index of Consumer Prices (HICP) fell to the bank’s target of 2% in August, increasing the likelihood of an interest rate cut.

Despite increasing expectations of an ECB rate reduction, the outlook for the popular forex pair will likely depend on both Euro Area and US inflation figures. While a 25 basis point cut is expected in Europe, the probability of a 50 basis point cut by the Federal Reserve has increased to 30%, adding significance to the US CPI report released today, Wednesday. Falling inflation in the US could offer upside for the EUR/USD pair. Let’s take a closer look:

Expectations from the ECB’s September Meeting

Markets expect the European central bank to deliver its second rate cut this year at its 12 September meeting with an 85% probability. Expectations have been supported by inflation falling to 2.2% year-on-year (YoY)  in August from 2.6% in July for the first time in three years, contrasting recent prints of stickier inflation and somewhat stable GDP growth that led to avoiding technical recession in Q2. However, the German economy, Europe’s largest, still experienced a contraction.

The market anticipates the rate cut, suggesting the focus might be on whether the ECB proceeds with another rate cut in October. This adds weight to the bank’s guidance for inflation and GDP, with a higher inflation or GDP guidance offering a potential rebound for Europe’s currency. 

If the ECB downplays an October rate cut, there is potential for some hawkish repricing, potentially pushing EUR/USD towards the 1.11 area due to a potential spread tightening. On the other hand, if the ECB guides slower inflation or raises rhetoric around recessionary risks, it would increase the chances of an October cut and may weigh on the EUR/USD pair. Currently, there is a 40% chance of a rate cut next month.

However, ECB policymakers do appear divided on the Eurozone’s outlook due to strong consumption and wage growth, with the internal debate potentially leading to slower cuts. During a period seen as bearish for the dollar due to increasing chances of a 50 basis point cut by the Fed, the EUR/USD could benefit after all.

In addition, the ECB plans to reduce the spread between its deposit and refinancing rate to unwind its excess liquidity and minimise volatility through a reduced rate spread. Although this may not directly impact the currency rate, it could encourage banks to lend out more at a lower borrowing cost.

Still, these are all projections, and only time will tell what lies ahead for this central bank and its implications for the Forex market.

The Policy Outlook Beyond September

Economists expect the ECB to proceed with another interest rate cut in December currently, while the October meeting remains less certain. However, should economic data progress in a similar fashion in the EU, the ECB may tilt towards more cuts. The forecast for 2025 suggests a target rate of 2.50% by next September, down from the current 3.75% deposit rate.

Given the ECB’s data-dependent and gradual approach to cutting interest rates, updated macroeconomic projections will be critical to assessing the bank’s path forward. At current, GDP growth is widely expected to remain unchanged at 0.9% in 2024, 1.4% in 2025 and 1.6% in 2026, while a downward revision in the 2025 and 2026 inflation forecasts of 2.2% and 1.9% in 2025 and 2026 may guide investors on future rate-cut decisions. 

Morgan Stanley (MS) analysts believe that weak GDP and inflation data in Europe may prompt the ECB to proceed with rate cuts at a faster clip than the Fed, ultimately leading to 1.02 by the end of this year. Such a fall in such a short time places Thursday’s meeting at a critical junction.

Besides these factors, weak demand from China and potential political instability in Europe could weigh on the euro, impacting consumer sentiment and economic performance and pressuring the euro. This is on top of the upcoming US election, which could influence the greenback’s trajectory. (Source: Reuters)

Conclusion

The ECB is widely expected to reduce interest rates in September, but the outlook for EUR/USD will likely depend on ECB guidance and whether rhetoric around the Fed’s cuts changes following US inflation data. With ECB policymakers debating Europe’s economic outlook, the path to lowering rates may be slower than expected unless the bank revises inflation or GDP growth downward.

Investors might focus on both sides of the currency pair to gain a more complete perspective of the potential influence on EUR/USD as they could impact the relative strength of the euro and dollar.