Traders have tempered their expectations for additional rate cuts from the European Central Bank (ECB) following a recent meeting that offered little insight into future monetary easing. Despite the ECB’s recent reduction of its key deposit rate to 3.50%, sources told Reuters that another cut in October is unlikely unless economic conditions worsen significantly.
In the latest meeting, the ECB lowered rates for the second time in this cycle but stressed that high services inflation would keep rates restrictive for as long as needed. ECB President Christine Lagarde emphasized that future rate decisions will be made on a meeting-by-meeting basis without pre-commitments.
As a result, traders have scaled back their expectations for a 25 basis point cut in October to about 20%, down from over 30% before the meeting. For the year, traders now forecast a total of 33 basis points in cuts, slightly less than the previously anticipated 36 basis points.
The market’s reaction to the ECB’s cautious stance was swift, with eurozone government bond yields rising sharply as rate cut expectations adjusted. Germany’s two-year yield increased nearly 10 basis points, marking its largest daily rise in almost a month. The euro also strengthened, trading up 0.25% at $1.10393, while European stocks ended the day positively.
With the U.S. Federal Reserve expected to implement back-to-back rate cuts starting next week, market focus is shifting to how the ECB’s divergent approach will impact markets. Traders anticipate around 100 basis points in Fed rate cuts this year, including a significant 50 basis point cut at an upcoming meeting.
Analysts have noted that the ECB needs to consider the euro’s strength, as a stronger currency could exacerbate financial conditions for the eurozone’s sluggish economy. Danske Bank’s chief analyst Piet Christiansen suggested that the ECB’s October decision could be influenced by aggressive moves from the Fed.
Despite lowered expectations for ECB rate cuts, the euro’s near-term gains are seen as limited. A Reuters poll forecasted the euro to rise to $1.11 by February and $1.12 in a year, staying near its August peak. Investors holding long positions in the euro may need to rely on stronger performance in other regions compared to the U.S.
On the bond front, some investors see potential in eurozone government bonds, which have lagged behind U.S. Treasuries. Mario Baronci, a multi-asset fund manager at Fidelity International, highlighted European bonds as a safer investment amid the current economic landscape.
The ECB’s recent decisions have led to a shift in market expectations for future rate cuts. As the central bank navigates a challenging economic environment with slow growth and persistent inflation, the divergence from U.S. monetary policy could have significant effects on the eurozone’s financial markets. Upcoming meetings and economic data releases will be crucial in shaping the ECB’s future direction and influencing market sentiment.