EUR Breaking New Ground Amid Shifting Monetary Policies

The euro has recently consolidated at higher levels, signalling a potential shift in the currency's trading dynamics. After breaking out of the 1.0500 to 1.1000 trading range that had dominated much of the landscape since late 2022, the euro is now trading within a new, higher range between 1.1000 and 1.1500. This move is particularly noteworthy given the currency's previous struggles to maintain momentum above the 1.1000 level. However, this time around, the euro's ascent appears more sustainable, underpinned by a confluence of factors that suggest a fundamental shift in market expectations and economic conditions.

One of the primary drivers behind this newfound strength is the anticipated monetary policy divergence between the Federal Reserve and the European Central Bank (ECB). The market has begun to price in the likelihood that the Federal Reserve will soon initiate a rate-cutting cycle, with expectations of at least 75-100 basis points in reductions by the end of the year. This shift in the US monetary policy stance reflects growing concerns about the resilience of the US economy in the face of global economic headwinds, including slowing growth in China, persistent geopolitical tensions, and tighter financial conditions. As the Fed pivots towards a more accommodative stance, the relative attractiveness of the US dollar is likely to diminish, providing further support for the euro.

In contrast, the ECB is expected to take a more measured approach to easing as the year progresses. After implementing a 25-basis point rate cut in June, the ECB is widely expected to lower rates by an additional 25 basis points this month. Importantly, the ECB refrained from making consecutive rate cuts at the July meeting, a decision that has been interpreted by the market as a signal of caution. As a result, a 25-basis point reduction in September is almost fully priced in, which should mitigate any significant downside risks to the euro in the near term.

However, the ECB's future policy trajectory remains a key focus for market participants. The central bank's updated guidance will be closely scrutinized to assess whether it will maintain a quarterly pace of cuts or potentially accelerate its easing cycle. As it stands, the euro-zone rate market is pricing in approximately 37 basis points of cuts by the October meeting, reflecting some degree of uncertainty and speculation about the ECB's next moves. I’m expecting that the ECB will continue with a quarterly rate cut schedule, with the third cut likely occurring in December rather than October. This more gradual approach aligns with MUFG outlook for modest euro strength against the US dollar, as it suggests that the ECB is not in a rush to aggressively ease monetary policy, thereby preserving some support for the euro.

Complicating the ECB's decision-making process is a growing divergence in views among its policymakers. A recent Reuters report highlighted emerging disagreements within the ECB regarding the growth outlook, which could add a layer of complexity to policy deliberations beyond this month. The more hawkish members of the ECB have emphasized that actual growth figures this year have consistently outperformed weaker survey results, bolstering their argument for a cautious approach to rate cuts. These members are concerned that moving too quickly with rate reductions could jeopardize the ECB's ability to achieve its inflation target of 2% within a reasonable timeframe, potentially pushing the target date out to 2026.

Given this backdrop, it seems unlikely that ECB President Christine Lagarde will strongly signal another rate cut for October at the upcoming September meeting. Instead, she is more likely to stress the importance of maintaining a flexible, data-dependent approach, with decisions being made on a meeting-by-meeting basis. This cautious tone would help manage market expectations and allow the ECB to respond more nimbly to evolving economic conditions. Moreover, by avoiding a clear commitment to further rate cuts in October, Lagarde could provide the ECB with the necessary leeway to adjust its policy stance should inflation or growth dynamics shift unexpectedly.

In conclusion, while the euro's recent strength marks a notable shift in the currency's trading range, its future trajectory will largely depend on the interplay between US and euro-zone monetary policies. The Fed's move towards easing, coupled with the ECB's more measured approach, creates a supportive environment for the euro. However, the underlying risks associated with diverging views within the ECB and the potential for unforeseen economic developments suggest that market participants should remain vigilant. The euro's path forward is likely to be shaped by a delicate balance between growth, inflation, and central bank actions on both sides of the Atlantic.

This content may have been written by a third party. ACY makes no representation or warranty and assumes no liability as to the accuracy or completeness of the information provided, nor any loss arising from any investment based on a recommendation, forecast or other information supplies by any third-party. This content is information only, and does not constitute financial, investment or other advice on which you can rely.