Euro-Dollar Closing On 1.10 As ECB Resists Rate Cut Bets

Above: ECB president Christine Lagarde giving the monetary policy statement during the ECB Governing Council Press Conference in Frankfurt, 14 December 2023. © Felix Schmitt for ECB.

The Euro to Dollar exchange rate extended its advance towards the 1.10 marker following the European Central Bank's decision to maintain key lending rates at existing levels and issue guidance that poured cold water on expectations for a rate cut as soon as March.

Euro-Dollar touched 1.0990 after the ECB issued guidance that retained the crucial phase that "rates will be set at sufficiently restrictive levels for as long as necessary".

The exchange rate had jumped just hours earlier when the Federal Reserve's policy update saw Chair Jerome Powell effectively condone market bets for up to 150 basis points of rate cuts in 2024. By contrast, ECB President Christine Lagarde said the Governing Council "did not discuss rate cuts at all," undermining the market's pre-meeting expectation for a first ECB rate cut in March 2024.

Euro-Dollar is, therefore, highly alert to shifting rate-cut expectations on either side of the Atlantic, and recent developments have gone in the Euro's favour.

"The euro rose to almost $1.10 following today’s policy announcement and press conference. The euro also pared losses against the pound which had risen following the earlier policy update from the Bank of England," says Hann-Ju Ho, Senior Economist at Lloyds Bank.

Subtle guidance shifts, as well as the new set of economic forecasts from the Bank's staff, show the ECB has almost certainly delivered its last rate hike.

"The end of rate hikes is here," says Carsten Brzeski, Global Head of Macro at ING, but, "for now, we still think that the ECB’s shift to full dovishness will be more gradual than markets are pricing in."

The market entered Thursday's decision with 150 basis points of rate cuts priced into 2024, meaning the bar for this number to rise even higher was incredibly limited owing to the already pregnant pricing, putting a floor under the Euro.

In fact, the prospect of a reversal in these expectations was likely the easiest route available to the market, which would be consistent with Euro-Dollar's strength.

This has played out.

EURUSD pressres higher

Above: EURUSD presses towards the November highs after two days of busy central bank action. Track EUR with your own custom rate alerts. Set Up Here.

The new inflation forecasts from the ECB are proving instrumental in offering support to the exchange rate, as there are still no scenarios whereby inflation falls to the 2.0% target on the forecast horizon.

The 2023 inflation forecast is lowered to 5.4% from 5.6%, 2024 to 2.7% from 3.2%, and 2025 remains unchanged at 2.1%.

With inflation expected to stay above target across the forecast horizon, the message that rates will stay higher for longer is given credibility, supporting the Euro.

"It is hard to see how the ECB could decide on a full U-turn on policy rates only on the back of a few weaker-than-expected inflation prints without headline inflation falling below 2% and the longer-term inflation forecasts still being at around 2%," says Brzeski.