Euro declines ahead of ECB 📌

Lagarde is expected to announce a 0.25% rate cut decision today 📄

• The ECB is widely expected to cut rates by 25 bps at its upcoming meeting.
• Headline inflation is projected to drop below 2% by early 2025.
• The eurozone economy remains sluggish, with risks skewed to the downside.
• Christine Lagarde reinforced the need for structural reforms at Davos.
• The ECB is expected to cut rates by 100 bps this year, with a potential slowdown in easing pace after March.

Rate Cut in Focus

The European Central Bank (ECB) is poised to reduce its key interest rate by 25 basis points at today’s policy meeting, aligning with market expectations. This move follows persistent signals from ECB officials that monetary easing will continue to counterbalance economic weakness while ensuring inflation remains anchored.

Moreover, the ECB is expected to deliver a total of 100 bps in rate cuts throughout 2025. However, while monetary easing in January and March appear likely, the pace of cuts may slow thereafter. By mid-year, policymakers will reassess economic conditions, particularly regarding services inflation, before deciding on further reductions.

The market is currently pricing in a 100% chance of a 0.25% rate cut at today's ECB meeting. Moreover, by the end of the year, investors are pricing in between 3 to 4 rate cuts, implying a deposit rate in December between 2.00% and 2.25%. Source: Bloomberg Finance LP.

Inflation Expectations

Despite some recent upticks, the broader disinflationary trend continues. ECB projections indicate that headline inflation will likely dip below the 2% target in Q1 2025, driven by base effects from energy prices and moderating services inflation. While core inflation remains somewhat sticky, underlying pressures from profit margins and labor costs have eased, suggesting further downward momentum in price growth.

Source: xStation 5

Economic Growth Concerns

The eurozone economy continues to struggle, with risks tilted to the downside. Recent economic data highlights weak consumer spending and sluggish business investment, partly exacerbated by uncertainty over U.S. trade policy. 

The latest GDP data for Q4 2024 was published today, confirming a further slowdown in the Eurozone economy. On a quarter-on-quarter basis, the EU economy remained unchanged, while on a year-on-year basis, it grew by only 0.9%, falling short of expectations of 1.0%. Source: xStation 5

Lagarde’s Stance at Davos

At the World Economic Forum in Davos, ECB President Christine Lagarde reaffirmed the need for continued monetary easing while emphasizing the importance of structural reforms. She highlighted the challenges facing the eurozone, including geopolitical uncertainties and financial fragmentation, but maintained that inflation risks are largely balanced. Lagarde also acknowledged that the debate over the neutral rate is gaining traction among policymakers.

Market Implications

The ECB's dovish stance and the weakness of the European economy have been priced in by the market for some time, which is reflected in the EUR exchange rate. However, the downward trend in EURUSD is not only due to EUR weakness but also to a very strong USD.

However, the EURUSD exchange rate has stalled at a key support level and has now resumed its decline. Today, EURUSD is down 0.10%, and the euro is one of the weakest G10 currencies just ahead of the ECB decision. The market expects a dovish stance from Lagarde. Since this outlook seems to be already priced in, greater volatility in the currency pair could be driven by unexpectedly slightly more hawkish comments. However, at this point, the likelihood of such a scenario materializing remains low.

Source: xStation 5