ECB MAINTAINS DATA-DEPENDENT STANCE
The European Central Bank (ECB) is expected to maintain a data-dependent stance in its January policy meeting, not prioritizing pushing back against market expectations of rate cuts. President Lagarde is likely to emphasize data dependency. Significant changes in the ECB’s language are not expected this month.
LIMITED MARKET IMPACT IF BASELINE SCENARIO HOLDS
If the baseline scenario materializes, market implications are expected to be limited. There may be a slight rise in rates and the euro initially, but it should not be a lasting effect. Market reactions may become more dependent on upcoming inflation and activity data in the eurozone rather than ECB member comments.
RATES: NEAR-TERM EXPECTATIONS DAMPENED, BUT RATE CUTS STILL ANTICIPATED
Market expectations currently price in nearly 140 basis points (bp) of policy easing by the ECB throughout the year. Despite some pushback from the ECB in December, this expectation persists. Some officials have openly discussed the possibility of rate cuts in the summer or earlier. However, data remains the key determinant, and the ECB may lay out criteria for considering rate cuts, which could dampen near-term expectations but only moderately lift rates.
FX: EUR/USD LIKELY TO REMAIN RANGEBOUND
The FX market is not expected to have a significant reaction to the ECB announcement unless President Lagarde provides clarity on the timing of rate cuts. EUR/USD has been rangebound and relatively detached from short-term rate dynamics. Market risk sentiment and equities have driven most of the recent EUR/USD movements. The traditional short-term rate differential has limited explanatory power for EUR/USD due to the tight range in rate differentials and the equity rally in late 2023. EUR/USD may reconnect with its short-term dynamics if there is a convergence in EUR to dollar rates, driven by ECB rate cut repricing, which is a baseline scenario for 2024.
KEY TAKEAWAYS:
- The ECB is expected to maintain a data-dependent stance without pushing back significantly against market expectations of rate cuts.
- Limited market impact is anticipated if the baseline scenario holds, with a slight initial rise in rates and the euro, but no lasting effect.
- Market reactions may become more dependent on upcoming eurozone inflation and activity data rather than ECB comments.
- Market expectations currently include nearly 140bp of policy easing by the ECB throughout the year.
- EUR/USD is likely to remain rangebound unless there is clarity on the timing of rate cuts, with short-term rate dynamics less influential due to tight rate differentials and equity-driven movements.
Ref: Bloomberg, ING, Scotia, Citi