ECB is likely to keep its key interest rates unchanged.

• In a 14-month-long fight against inflation, the ECB has already hiked the rates 10 times.
• A pause in a rate-hiking cycle is now highly likely.
• The ECB must strike a delicate balance as inflation remains above the ECB’s  target, while Germany is in recession.
• The euro is at risk of further devaluation against the U.S. dollar. 

The European Central Bank (ECB) will meet on Thursday, October 26 to announce its interest rate decision. The market expects the ECB to keep its key interest rates unchanged - i.e., the benchmark deposit rate should stay at its current 4.00%, while the main refinancing rate should stay at 4.50%. According to Reuters, there is a strong consensus among the professionals about the upcoming decision. None of the 85 economists polled by Reuters over Oct. 12-19 expect a rate hike or a rate cut. Indeed, the ECB, itself, has suggested that its previous rate hike was probably the last one during the current tightening campaign.   

"Based on its current assessment, the Governing Council considers that the key ECB interest rates have reached levels that, maintained for a sufficiently long duration, will make a substantial contribution to the timely return of inflation to the target," the ECB said in a statement on September 14, 2023. 

Most recently, Francois Villeroy de Galhau, a prominent ECB policymaker and a governor of the French central bank, reiterated his belief that there was a risk in tightening the policy too much and that the ECB should keep its key interest rate at its current level.

“Whether we like it or not, the Eurozone economy is in the doldrums and raising the borrowing costs now would just further hit ordinary consumers already stressed by various externalities”, said Octa analysts.

Indeed, rising borrowing and living costs have already forced European citizens to rein in spending. According to Eurostat, consumer confidence remains on a downward trend, while retail sales continue to fall in annual terms. Although the Eurozone as a whole will probably avoid a recession this year, it will do so only narrowly, while its largest member, Germany, is probably already in a recession.  

“The European Central Bank finds itself between a rock and a hard place”, said Octa analysts, referring to the difficult decision facing the ECB on October 26. “There is no easy solution. The ECB would either have to risk triggering a recession or it would have to accept the high likelihood of inflation remaining above target for an extended time period. Therefore, I believe that we will see a hawkish pause. They will hit a pause and will keep the rates steady but at the same time their usual higher-for-longer mantra will be repeated again in the post-meeting statement as well as during the press conference”. 

At its previous meeting, the Federal Reserve (Fed) also opted to keep its benchmark rate unchanged. However, the U.S. economy remains relatively robust compared to its European counterpart. In fact, according to CME FedWatch Tool, there is even a 35% probability of another rate hike from the Fed in January next year. Conversely, the interest rate expectations in the Eurozone are more subdued. While both central banks remain ostensibly hawkish, the results they have achieved are quite different. The U.S. economy has been surprisingly resilient, while the Eurozone is stagnating. 

“Right now, the divergence between the U.S. and the Eurozone monetary policy is favoring the U.S. dollar and this divergence may become entrenched. As a result, the euro is facing further risks of devaluation. A confident break below 1.04450 potentially opens the way towards 1.02000 and then towards parity again. Only an assertive push above 1.07000 would invalidate the underlying bearish trend in EURUSD”, said Octa analysts. 

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