European currencies dragged down by downbeat ECB forecasts
The ECB meeting last week went mostly according to the script, with a 25bp cut and significant downward revisions to the bank’s view on Euro Area economic growth.
Highlights:
USD outperforms ahead of ‘hawkish cut’ from Fed.
ECB cuts rates, while lowering growth outlook.
BoE to hold rates steady, hint at ‘gradual’ cuts ahead.
JPY suffers as BoJ hike in doubt for this week.
CHF lags behind as SNB shocks with 50bp move.
CNY downside ahead as PBoC shifts FX stance.
Neither development really surprised markets, but the contrast between this gloom, and what is expected to be a “hawkish cut” from the Federal Reserve on Wednesday, made the dollar the best performing G10 currency last week. Performance was more mixed in emerging market currencies, most of which experienced modest rebounds after the brutal 2024 sell off that has brought them down to very undervalued levels.
Market attention is now squarely focused on the last Fed meeting of the year. A 25bp cut is almost universally expected, and the key will be the forward guidance on rates implied in the “dot plot”. Prior to that, the G3 PMIs of business activity will be published on Monday. We are keen to see if last month´s dismal European levels were a knee-jerk reaction to Trump’s electoral victory, or whether they indicate a deeper malaise. The UK labour market (Tuesday) and inflation (Wednesday) reports will be followed by the Bank of England meeting on Thursday, rounding out an important week of economic releases.
USD
The inflation report for November came out exactly as expected. Most notable was that the monthly number printed at 0.3% for the fourth consecutive month, consistent with an annualised rate just below 4%. This will undoubtedly be a concern for FOMC officials, and will raise anxiety levels among the committee that progress on bringing down US inflation has stalled.
While we expect the Fed to cut rates by 25 basis points this week, we expect the forward guidance to move in a hawkish direction. Chair Powell will likely continue to stress that US growth remains strong, and that the labour market continues to add jobs at a solid pace, despite the miss in the October payrolls report. The key to the USD reaction will likely be how many cuts are indicated in the dot plot of rate projections. Futures markets are currently pricing in three rate reductions in 2025, but we think that it may be a struggle for the Fed to justify more than two.
EUR
The last European Central Bank meeting of the year delivered on what most of the market had expected: a 25 basis point cut, and a somber downgrade of its expectations for Eurozone growth in 2025 and 2026, which Lagarde hinted could be negatively impacted by Trump’s tariffs. The HICP projections were left largely unchanged, although the bank did revise downwards its view for core inflation.
The downbeat assessment probably means that there will be additional cuts at every meeting in the first half of 2025. The euro took this in stride , in large part as markets were already pricing in a very dovish message prior to the meeting, and the common currency managed to end the week just up against the dollar. The next big test will be the December flash PMIs of business activity, which took a dive in November after Trump’s electoral victory. A rebound here is not out of the question now that the initial shock has worn out.
GBP
Last week’s highly disappointing October GDP data, which showed the first back to back monthly contraction since the COVID-19 pandemic (-0.1%), sets the stage for this week’s Bank of England meeting, which will take place right after the PMIs and the November labour and inflation reports are released. It is unusual to see a central bank decision held immediately after such a deluge of economic data, but the latter are not expected to sway the MPC into cutting rates.
We see no change as a near certainty this week, indeed markets are only pricing in 4 basis points of cuts. This week’s data could, however, impact the number of dissenters who vote for a cut (7-2 currently seen by the consensus). We think that high rates, resilient growth and continued rapprochement with the EU will enable sterling to rise against both the dollar and the euro going into 2025.