Euro strength 'casts doubt' on ECB rate trajectory as Lagarde to hold rates

The latest economic news from the Euro Area has broadly confirmed that the economy has a palpable pulse and is growing at or near potential. The PMIs have eased from their recent highs, with the composite PMI printing at 51.5 at the turn of the year. Meanwhile, growth surprised to the upside, keeping its momentum in the fourth quarter (+0.3% QoQ), with Germany, Spain and Italy sending encouraging signals.

There are hopes that German fiscal stimulus will breathe fresh life into the Eurozone’s largest economy, but the complex global trade landscape and structural issues will likely keep a lid on activity.

The inflation landscape points to largely contained price pressures. In fact, the risk of inflation undershooting the target appears to have increased amid the rapid appreciation of the euro. The pass-through effect is not as high as in some other major economies, such as Switzerland, but a stronger euro does lower import prices to a non-negligible extent.

It also negatively affects export competitiveness, which is highly important for the bloc. In this context, markets, which just a few weeks ago were leaning towards a rate increase as the next change from the ECB, now see a 1-in-5 chance of a cut before year-end.