What could move the markets after the ECB decision might not be the change in interest rate, but what it does to set up for future rate moves. Both the market and economists are in agreement that the European Central Bank will cut rates by a quarter of a percentage point on Thursday But there is a huge debate over what happens after that – including inside the ECB itself.
Public commentary from monetary policy committee members has shown a divide between those who worry that there is a pending recession in Europe and those who are still worried about inflation. There is similarity between the usual North-South divide around easing, with northern countries favoring more restrictive policies and southern ones more loose policy. But what matters is which side of the debate is gaining ground, because that could determine how fast the ECB decision cuts rates going forward.
It’s About the Comparables
What moves the Euro in general is where traders think interest rates will be with respect to other central banks. Right now, the market is pricing in two rate cuts from the ECB, one from the BOE and three from the Fed. If the ECB shows signs of doing more cuts, then that would weaken the Euro. Or, if the ECB were to show signs of slowing the pace of cutting, then it would strengthen the Euro.
This meeting is special, because it not only has the rate decision, policy statement and ECB President Christine Lagarde’s press conference to give insight into what could be coming in terms of monetary policy. It also has staff projections, which show where the ECB thinks inflation and economic growth will be over the next couple of years. On top of all that, traders also anticipate that the bank will also narrow the gap between the deposit rate and the main refinancing rate, a technical move that is seen as having an overall easing effect on the markets.
What to Look Out For
With the raging debate over whether the Euro Area is headed for a recession or not, the staff projections could be the key to figuring out which vision will win out in the end. Last time around, the ECB staff said that inflation would reach the target during next year, and that growth would accelerate. That’s the forecast the ECB used to cut rates last time, implying further cuts going forward.
If the staff tweak the projections with inflation reaching its target sooner than before, that could leave the market thinking that the ECB will be more aggressive in its easing. Similarly if the economic growth forecast is cut. But the reverse could happen as well, such as simply maintaining the growth forecasts, which could be seen as a sign that the hawks have the upper hand.
Who’s Winning the Debate
Then there is the usual paying close attention to the rhetoric used by the head of the ECB during her press conference. Talk of staying data dependent would likely reassure the market that the expected rate cut of December is on track, since traders believe that’s what the data will show.
But, if she provides more emphasis on economic growth issues, then traders could get the impression that the recession argument is gaining traction. That would increase expectations for rate cuts, which could weaken the Euro against the dollar, particularly heading into the Fed’s own rate decision next week.