➡️EURUSD above 1.09 before the ECB

Market expects a dovish ECB stance , although attention should be focused on projections 🔎

• The market is expecting a very dovish message from the ECB
• Communication over the past months has indicated a desire to keep interest rates high for an extended period. Lagarde may want to dampen expectations for strong cuts
• The market expects interest rates to be held today and as many as 6 cuts next year
• Eurozone inflation is very close to the inflation target
• Inflation projections will be key to the EURUSD's further fortunes in today's session

 

Will the ECB change its communication like the Fed?

A lack of interest rate hikes in the eurozone seems more than certain. The key question, however, is whether the ECB will change its communication regarding interest rates next year. For many months, ECB bankers suggested that interest rates could be maintained at the same level throughout the next year, but at the same time, a significant drop in inflation and the risk of a recession may force the ECB to cut rates earlier than the Fed. Moreover, the Fed's pivot allows for a similar move by the ECB.

The market expects the first interest rate cuts in the eurozone to appear as early as spring. However, this is too early, considering the latest communication from European bankers. Source: Bloomberg Finance LP, XTB

Lagarde has repeatedly emphasized during recent meetings that we should not expect interest rate cuts in the coming quarters. However, the situation is changing dynamically. Inflation for November fell to 2.4%! In July, it was more than twice as high. With a deposit rate at 4.0% and current inflation, real interest rates seem extremely high.

 

What to expect from ECB projections and Lagarde?

Certainly, Lagarde should indicate that further interest rate hikes should no longer occur, although this will be said more gently. With such a statement, there is a chance for the euro to weaken. Additionally, Lagarde should note the recent drop in inflation but emphasize the risk of its rebound next year. Nevertheless, the inflation projection for 2024 should be lowered. It currently stands at 3.2%. At the moment, projections indicate a target of 2% by mid-2025. Today's results may give a chance to achieve this goal earlier.

Moreover, there is also a chance for "tightening" communication regarding the PEPP program and balance sheet reduction. Given the mitigation of risks related to yield increases in countries like Italy, there is a chance to accelerate balance sheet reduction and quicker cessation of PEPP program reinvestments. If such communication occurs, there would be a chance for the continuation of the euro's strengthening. Of course, the ECB will still keep in mind the significant risk of a potential recession.

 

A possible EURUSD reaction?

The euro remains one of the weaker currencies in the market, as expectations point to a dovish message from the ECB. At the same time, the dollar is even weaker, allowing for a 0.3% gain on the EURUSD pair and a move above the 1.09 level. Investors are reacting to a more pronounced central bank pivot, with speculation in the markets now centered around the prospect of the first interest rate cuts. Just as importantly, EURUSD has already gained nearly 1.40% in 3 sessions, approaching the key 1.100 level again.

Although Lagarde is unlikely to be as dovish as the market sees it, inflation projections may give an indication of faster interest rate cuts. For further strong EURUSD appreciation, Lagarde would have to assure that rates would remain unchanged for the next few quarters, and the ECB itself would have to change its communication on the balance sheet and PEPP. If inflation projections go sharply down, a correction on EURUSD cannot be ruled out.

​​​​​​​Source: xStation 5