Change of plan
The ECB’s decision to adjust policy in June hadn’t been a consensus view within the market. The probability of a rate cut increased into the decision, but many had expected the Bank to keep rates on hold, pausing to take stock of policy adjustment to date. The decision last month to make another pre-emptive cut in the face of receding inflationary forces despite widespread macroeconomic uncertainty was seen to limit if not extinguish any chances of a July rate cut. Well, here we are, on 22nd July with just two trading sessions left until the next ECB meet is upon us and things don’t look so straight forward. Despite this, a hold still looks like the most likely outcome with a dovish tail risk.
What certainly hasn’t changed is that disinflationary concerns continue to fuel a bias towards cutting rates. Growth and price level concerns continue to make the thought of rate hikes at this time unpalatable and any considerations for adjustment to monetary policy favour loosening or a ‘wait and see’ approach. However, since the ECB’s last meeting two key developments have unfolded. First and most importantly, the failure between the US administration and EU to secure a permanent deal on trade and tariffs leaves trade policy beyond August 1st uncertain. As we, write the EU continues to draft retaliatory measures should negotiations continue to fail. When the ECB made its last decision to cut rates, the tariff backdrop was for 10% universal tariffs and Trump’s current threat of 30% come August 1st wasn’t even in the disaster scenario.
The second and sustained substantive change has been in the value of the Euro. Now, the ECB doesn’t have a target for the Euro per se. Given the trade weighted exposure of European trade, we are mostly but not exclusively talking about EURUSD here. Amongst this pair, the hidden number causing concern is 1.20. However, policy makers will always remind us it is the rate of change of the currency that may cause concern to monetary policy transmission not its absolute level. EURUSD does remain meaningfully elevated, and more policy makers have been observed talking about exchange rates. Thursday could well be the next time we see an ECB President take aim at the currency warning of any further assent and its impact upon the bank’s ability to cut rates.
Discussion and Analysis by Charles Porter
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