EUR_2_M EUR_2_M EUR_2_M

ECB Preview: Will EUR pay heed to the pushback to April cut expectations?

Forex 5 minutes to read
Charu Chanana 400x400
Charu Chanana

Head of FX Strategy

Summary:  ECB meeting is on tap this week, and officials are expected to pushback on H1 easing expectations as they wait for wage data. However, we see economic risks likely to remain top of mind for markets, and some of that pushback has already been priced in after comments from Davos last week. As such, bearish EUR picture remains in play and expect EURUSD to stay in the 1.08-1.10 range.


ECB likely to push more firmly against aggressive easing expectations

The European Central Bank will announce its next policy decision on January 25 and no change is expected to policy rates. However, the discrepancy in the Bank’s expectation of the rate curve and that of the market remains a key debate. Market is currently pricing in over 65% odds of a rate cut in April and 43bps of easing by June. In contrast, ECB officials have presented a rather united front in pushing back against these expectations with President Lagarde sending a strong signal last week at the Davos meetings where she said that cuts are likely only to begin by summer. That would mean June or July, with Lagarde saying that information needed to assess the strength of wage pressures would only be fully available by “late spring”.

Broad rhetoric is unlikely to be any different, but the bigger question is whether it makes sense and if the market will adjust expectations as a result.

Is the focus on wages justified?

Comments from the ECB suggest that the main hurdle to a rate cut are wages, with unemployment at record lows. Pay growth, as tracked by recruitment platform Indeed, is down to 3.8% in December from 5.2% in October 2022, but the ECB wants to see it fall towards the 3% mark that is seen to be consistent with achieving 2% inflation. What makes ECB jittery is that 40% of European workers will be entering 2024 wage negotiations, and initial reports from IG BAU union suggest upward pressure continues. The salaries of steel-industry and public-sector employees will rise by more than 5% in 2025, while construction workers want a 21% increase for the lowest-paid majority.

However, wage data is lagging, and it is worth noting that headline inflation and inflation expectations have eased. December headline inflation came in at 2.9% YoY, higher than 2.4% YoY in November but due to base effects. Core CPI however eased to 3.4% YoY from 3.6% in November, and was the lowest since March 2022. ECB’s survey of inflation expectations have also pointed to both 1-year ahead and 3-years ahead falling quite sharply in November with the former sliding from 4% to 3.2% and the latter from 2.5% to 2.2%. Some analysts have argued that Eurozone inflation risks could return amid the shipping delays related to disruptions in the Red Sea

Meanwhile the Eurozone economy is starting to show cracks, and high real rates could bring further pressures if the ECB continued to wait for the wage data. Q4 GDP growth is only due on January 30, and a negative print will confirm that the Eurozone is in a recession after Q3 GDP growth came in at -0.1%. Even if the Eurozone managed to avoid a technical recession, the best case scenario would be that of a stagnation. November retail sales came in at -0.3% MoM and December Euro-area manufacturing PMI of 44.4, near a 3-year low, suggests that goods demand remains weak. Services PMI at 48.8 for December has remained in contraction for five straight months. Euro-area consumer confidence surprised on the downside as it dropped to -16.1 in January from -15.1 previously, reversing some of the improvement seen in the last 2 months. ECB Bank Lending Survey also noted credit standards tightened in Q4 for firms and households, with further tightening expected in Q1. In summary, the outlook for Eurozone growth is worsening fast, and may not leave room for the ECB to wait until the summer.

24_FX_ECB
ECB 1-Yr Inflation Expectations. Source: Bloomberg

Scope for tactical EUR long but bearish sentiment to prevail

With two opposing arguments that ECB is likely to pushback further on easing expectations, but the health of the Eurozone economy decelerating fast, what will the market react to?

We believe EUR will be more sensitive to growth metrics from here, so PMIs due today (24/1) or Q4 GDP data due next week (30/1) will be key. The ECB meeting itself is unlikely to be a turning point for EUR. Market has also already priced in some ECB pushback after the rhetoric from Davos last week, so it will not come as a surprise. April rate cut pricing is now down to 17bps from 28bps at the start of last week.

24_FX_MIPR
ECB Rate Curve Pricing Shift. Source: Bloomberg

Tactically, given that USD strength is now looking excessive and EURUSD is finding support at its 200DMA, there may be some room for a tactical rebound if the pushback is more forceful than last week, but this is unlikely to stick and a bearish picture remains. EURUSD needs to break above 50DMA at 1.0922 and test the 23.6% fibo retracement level at 1.0976 to confirm a short-time upside trend. For now, EURUSD looks set to continue its range trading in 1.08 to 1.10 area.

Also, worth noting that equity and risk sentiment is turning out to be a bigger driver for FX moves lately, rather than rate differentials. Any turn lower in US equities, potentially driven by earnings disappointment, could boost USD and in turn weigh on EUR. Watch for a break below 1.08. EURCHF and EURJPY are also likely to move lower in that scenario.

24_FX_EUR
Source: Bloomberg, Saxo

-----------------------------------------------------------------------

Other recent Macro/FX articles:

23 Jan: Podcast: Central banks and key figures run the show
22 Jan: Weekly FX Chartbook: Soft-landing hopes and US exceptionalism will remain at play
19 Jan:  A reality check on Bank of Japan’s policy normalization and JPY appreciation expectations
15 Jan: Weekly FX Chartbook: UK data will be a test of GBP resilience
12 Jan: Markets ignore CPI uptick, Mideast tensions could fuel haven and oil-related FX
9 Jan: FX Quarterly Outlook: High yielding currencies will start to lose their appeal
9 Jan: US CPI Preview: Markets could be sensitive to an upside surprise
8 Jan: Macro and FX Podcast: Upcoming US CPI figures, USD momentum, and musings on China
8 Jan: Weekly FX Chartbook: Room for tactical gains in USD
18 Dec: Macro and FX Podcast: Watch USD sentiment and BoJ hints on rate policy
18 Dec: Weekly FX Chartbook: Dollar to end 2023 in a bearish trend
15 Dec: ECB’s policy mistake, Bank of Japan comes next
13 Dec: Fed has a final chance to pushback on rate cut expectations
11 Dec: Weekly FX Chartbook: Relative Fed and ECB policy messaging to matter more than absolute stances
11 Dec: Macro and FX Podcast: Will central banks, inflation, and PMIs deliver fireworks?
8 Dec: Exploring the impact of US NFP on different asset classes, BOJ will stick with gradualism
5 Dec: RBA under-delivers: AUD momentum could turn bearish, particularly on the crosses
4 Dec: Weekly FX Chartbook: Dovish Fed and ECB bets picking up
4 Dec: Macro and FX Podcast: Key macro data this week, the USD slide ended and gold is on the move
1 Dec: USD in a dovish fatigue, EUR gives up 1.10, and markets look to Powell

Disclaimer

The Saxo Bank Group entities each provide execution-only service and access to Analysis permitting a person to view and/or use content available on or via the website. This content is not intended to and does not change or expand on the execution-only service. Such access and use are at all times subject to (i) The Terms of Use; (ii) Full Disclaimer; (iii) The Risk Warning; (iv) the Rules of Engagement and (v) Notices applying to Saxo News & Research and/or its content in addition (where relevant) to the terms governing the use of hyperlinks on the website of a member of the Saxo Bank Group by which access to Saxo News & Research is gained. Such content is therefore provided as no more than information. In particular no advice is intended to be provided or to be relied on as provided nor endorsed by any Saxo Bank Group entity; nor is it to be construed as solicitation or an incentive provided to subscribe for or sell or purchase any financial instrument. All trading or investments you make must be pursuant to your own unprompted and informed self-directed decision. As such no Saxo Bank Group entity will have or be liable for any losses that you may sustain as a result of any investment decision made in reliance on information which is available on Saxo News & Research or as a result of the use of the Saxo News & Research. Orders given and trades effected are deemed intended to be given or effected for the account of the customer with the Saxo Bank Group entity operating in the jurisdiction in which the customer resides and/or with whom the customer opened and maintains his/her trading account. Saxo News & Research does not contain (and should not be construed as containing) financial, investment, tax or trading advice or advice of any sort offered, recommended or endorsed by Saxo Bank Group and should not be construed as a record of our trading prices, or as an offer, incentive or solicitation for the subscription, sale or purchase in any financial instrument. To the extent that any content is construed as investment research, you must note and accept that the content was not intended to and has not been prepared in accordance with legal requirements designed to promote the independence of investment research and as such, would be considered as a marketing communication under relevant laws.

Please read our disclaimers:
Notification on Non-Independent Investment Research (https://www.home.saxo/legal/niird/notification)
Full disclaimer (https://www.home.saxo/legal/disclaimer/saxo-disclaimer)
Full disclaimer (https://www.home.saxo/legal/saxoselect-disclaimer/disclaimer)

Saxo Bank A/S (Headquarters)
Philip Heymans Alle 15
2900
Hellerup
Denmark

Contact Saxo

Select region

International
International

Trade responsibly
All trading carries risk. Read more. To help you understand the risks involved we have put together a series of Key Information Documents (KIDs) highlighting the risks and rewards related to each product. Read more

This website can be accessed worldwide however the information on the website is related to Saxo Bank A/S and is not specific to any entity of Saxo Bank Group. All clients will directly engage with Saxo Bank A/S and all client agreements will be entered into with Saxo Bank A/S and thus governed by Danish Law.

Apple and the Apple logo are trademarks of Apple Inc, registered in the US and other countries and regions. App Store is a service mark of Apple Inc. Google Play and the Google Play logo are trademarks of Google LLC.