ECB cuts rates, but leaves it up to the market to decide where it goes next

The contrast to the Fed and the ECB was stark on Thursday. The ECB warned of headwinds to the economy, after the Eurozone economy flatlined in Q4, rising just 0.9% for the whole of 2024, while annualized GDP in the US rose by 2.3%. The ECB cut interest rates, as expected, and the interest rate futures market’s reaction to the ECB has been mildly dovish. The market is now expecting a further 60bps of rate cuts by June, with only 3 rate cuts expected this year, this suggests that the market is pricing in the possibility of a super-sized rate cut from the ECB at some point in the coming months.

A two-speed reaction to the ECB: Interest rate expectations fall, as the Euro claws back losses

There has been a dichotomy in the market reaction: interest rate futures are reacting to the dovish element of the ECB’s message, including its reference to economic headwinds, and the fact that the ECB believes that the disinflation process is ongoing, and inflation will fall back to the 2% target rate at some point this year. Lagarde also signaled that it is too early to talk about halting the rate cutting cycle, although at 2.75%, Lagarde will not be able to swipe this conversation for much longer.

However, the euro climbed on the back of Lagarde’s press conference. The ECB needs to balance economic headwinds, with the need to monitor inflation risks, and this is reflected in the performance of the euro. EUR/USD has erased the losses of the day and remains above $1.04. Lagarde helped to boost the single currency, when she played down the zero-growth rate for the currency bloc for Q4, instead she said that the economic recovery is still in play.

The mini bounce in the euro could reflect the fact that the ECB did not discuss a 50bp rate cut today, even though the decision to cut rates was unanimous. Upside pressure on the euro could be limited, as Lagarde says that wage growth is expected to moderate this year, which is a big development after elevated wage inflation in the currency bloc for a number of years.

ECB side swipes tariff and political talk

Conspicuous by his absence was any mention of Donald Trump. There was little reference to the new US President and the potential for on European exports. She did say that greater friction in global trade would make the inflation outlook less certain for the euro area. However, like the Bank of Canada on Wednesday, the ECB will not get dragged into politics.

Overall, this was an uneventful press conference. The rate cut was expected, and there are more rate cuts expected in the coming months. However, at some point the ECB will need to stop cutting rates, and the upside to the euro today, suggests that there is some expectation out there that we may be closed to the neutral rate for the Eurozone than Lagarde was willing to let on.