ECB preview: cut, cut, cut
The ECB meeting is scheduled for this Thursday at 1315GMT. The market is certain that the ECB will cut interest rates at this meeting and is 100% priced for a cut. We do not expect the ECB to disappoint market expectations. The impact from the rate cut is not expected to be particularly market moving, instead, the focus will be on ECB President Christine Lagarde’s press conference at 1345GMT and the ECB statement that will accompany the decision.
The market is already expecting an 88% chance of a cut in March, and a decent chance of a further cut from the ECB by June and a total of 3.5 cuts in 2025 in total. Thus, there is a limit to how dovish Lagarde can be at this meeting. There is a growing chance of a 50bp rate cut at some point in the first half of the year, and Eurozone interest rates are expected to end 2025 just above 2%. However, some analysts argue that rates need to fall further to boost the Eurozone economy due to multiple threats facing the currency bloc. Expectations are on the extreme dovish side as we lead up to this meeting, the question is, will Lagarde deliver on these dovish expectations?
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President Trump’s tariffs are the key threat for the Eurozone economy right now. Although Trump has spoken out about universal tariffs and has signaled that he is not happy with the Eurozone’s trade surplus with the US, he has not specifically mentioned tariffs for the currency bloc, unlike Mexico and Canada.
The problem for the ECB, is that they are at the mercy of US economic policy. If tariffs weigh further on growth in the currency bloc, then the ECB will be forced to act. However, it may be wise for the ECB to wait to signal a faster pace of rate cuts if/ when tariffs happen. This way, the Eurozone economy will see a bigger benefit from lower borrowing costs. If the ECB preempts tariffs and says that the pace of rate cuts will pick up at today’s meeting, then the market impact will be immediate, and this could mean there is nothing left in the ECB’s war chest if US tariffs do come down the line.
The ECB may follow the BOC
The ECB may choose to follow the Bank of Canada, who cut interest rates on Wednesday, and dropped forward guidance due to President Trump’s tariff threats. The BOC governor said that the threat of tariffs was clouding the economic outlook for Canada. This highlights the tricky situation central banks face in the age of Trump. The Bank of Canada is unwilling to make any pledges on the future of monetary policy util the details of Trump’s tariffs are made available.
Absent US tariffs, the Canadian economy is stronger than the Eurozone’s, and the BOC see risks to inflation as balanced. However, like parts of the Eurozone, Canada is also facing its own election risks, and if Trump follows through with his tariff threats, then Canada and the Eurozone could be in the same boat.
FX impact
Leading up to this meeting, the market is expecting a dovish stance from the ECB. Demand for short term risk reversals in EUR/USD has declined and is close to its lowest level since mid-2024. This suggests that the market is bearish about the outlook for the euro and is not positioning for a recovery. We think FX positioning in the euro is mostly due to fears about Trump’s tariff threats rather than the ECB meeting, and there is a decent chance that EUR/USD could fall to parity on the back of any tariff announcement.
However, the euro is still susceptible to volatility on the back of today’s ECB meeting. The euro has clawed back losses vs, the USD and the pound since the start of this year, and EUR/USD is higher by 0.8% above $1.04. A dovish ECB is mostly priced in by the market, so downside for the euro could be limited on the back of this meeting. However, if the ECB follows the BOC and does not provide forward guidance about interest rates, then we could see the euro stage a mini relief rally, and EUR/USD may test previous highs at $1.05.
Chart 1: EUR/USD 1-month risk reversal and EUR/USD, they follow each other closely, and it suggests that the market is positioned for a weakening of the euro.
Source: XTB and Bloomberg
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