Published: December 4th, 2024
Consensus is building that a 25-basis point rate cut from the European Central Bank (ECB) is the most likely scenario when Frankfurt central bankers meet next month. That should be good news for the Euro, analysts say, as lowering the odds for a more assertive 50bp move could provide near-term support.
Figures from Eurostat released this week show inflation in the Eurozone is up year-on-year from 2 per cent to 2.3 per cent. However, the definitive core inflation print dipped slightly from 2.8 pr cent to 2.7 per cent.
An analyst note from TD Securities said the Eurostat figures 'point to persistent core inflation,’ with a third consecutive monthly reading of 2.7 per cent.
“The ECB faces a difficult decision in December, as some Governing Council members believe a 50bps cut is the sensible move. Yet the picture painted by the most recent inflation and labor market indicators don’t fully support an aggressive rate reduction.”
TD says a look at money market pricing suggests forex traders see 37bp in cuts coming out of next month’s meeting in Frankfurt, up from the 25-point cut consensus but less than the more substantial 50bp move.
This points to a coming shift in the rates market towards one outcome or the other. TD analysts say that a further reduction in rate cut expectations would likely boost the Euro, with the inverse being true if expectations rise again for a 50bps cut.
‘If market expectations continue to move in the direction of a 25bps cut in December, then a mini recovery for EUR could be on the table in the short term. Long-term, however, we continue to see a weak outlook for the single currency."
In October 2022, figures from Eurostat showed that inflation in the Eurozone had reached a new record high of 10.6 per cent. Alongside rising prices, other metrics showed the bloc's economy growing faster than forecast in the third quarter.
The dual data releases split market opinion on likely next moves by the European Central Bank (ECB). With inflation going past the 10.3 per cent anticipated by the market there was pressure on Frankfurt central bankers to raise interest rates. Some economists, however, believed other pressures could compel the ECB to take its foot off the rate-hike pedal.
High fuel and energy prices continue to be the main driver of inflationary pressures. Since the outbreak of war between Russia and Ukraine, the price of oil and natural gas had rocketed upwards by almost 42 per cent year-on-year.
Food prices were the second biggest contributor to inflation, rising by an estimated 13 per cent in the year to October 2022. But there were price increases across the board, which suggested inflation was embedded in the economy and would stay above the ECB's two per cent target for the forseeable future.
The ECB lifted rates by 75 basis points in the week commencing 24th October 2022 and markets expected a similar jump in December after core inflation rose to five per cent, another record jump. That was anticipated be scaled back to a 50bp rise if new data showed that the Eurozone economy is slowing down in Q4.
Forex traders were betting on further rate hikes found some comfort in the news that the Eurozone economy grew by 0.2 per cent in Q3 2022, higher than 0.1 per cent consensus was expecting.
Seeing stronger-than-expected economic growth is typically supportive of the Euro, although economists warned that the Eurozone wouldn’t be able to resist sliding into negative growth for much longer.
An analyst note published by ING said that the eurozone contraction was on the horizon. ‘Even against a backdrop of incremental growth, inflation continues to rise at record rates. That suggested the eurozone economy is headed for a difficult winter since a recession is surely looming.’
Even with such sure signs of economic overheating, ING believed the ECB would slow down the pace of interest rate hikes before year’s end, a prediction that was borne out by events
‘As economic conditions start to weaken and a Winter recession takes hold, we think Frankfurt’s next rate rise will come in at a somewhat smaller 50 basis points. Given how large the total size of the hikes the central bank has delivered this year, slowing the pace of rate rises could also slow the Bloc’s economic growth in 2023.’
Energy and inflation hemmed in EUR for much of 2022. In August the Euro was down sharply against the Dollar and the Pound as the ECB fought to contain the impacts of surging gas prices.
The Ukraine conflict squeezed gas supplies in the Eurozone and analysts saw minimal prospects for a short-term turnaround. The Euro fell against the Pound in mid-April 2022 as Eurozone energy prices hit record highs and another shutdown of Russian gas supplies loomed on the horizon.
The benchmark Dutch TTF price for European gas rose to EUR 290 per MWh, pushing electricity supply contracts in France and Germany to new records.
Surging Eurozone electricity prices were aggravated further by nuclear power station outages in France, and the likelihood of more cuts to the supply of Russian gas in response to sanctions.
In late August 2022, the Kremlin said that the Nord Stream 1 pipeline that delivers gas to Germany would be shut for repairs for three days.
Economists at Allianz in Frankfurt said at the time that the decision was clearly a political one.
‘In what looks like a bid to exploit Europe’s dependence on Russian gas, Russia said that it will close the Nord Stream 1 pipeline for unscheduled 'maintenance' on 31 August. The decision to halt supplies is happening in the middle of a gas bidding war as European governments try to fill their gas storage facilities ahead of what looks to be a winter of political discontent.’
