The European Central Bank (ECB) is anticipated to maintain its record-high interest rates during its upcoming meeting on Thursday, signaling a potential cut in borrowing costs by the summer. This trajectory in policy direction has led some analysts to speculate that the euro may depreciate towards parity with the U.S. dollar.
Despite the headline eurozone inflation decreasing from its peak of 10.6% in October 2022 to 2.4% in March 2024, it still remains above the ECB’s 2% target. Consequently, the central bank remains cautious about reducing its deposit rate from the current 4% without further evidence indicating a reduction in price pressures.
ECB President Christine Lagarde recently highlighted this cautious approach, emphasizing the expectation of elevated services sector inflation throughout the year. She emphasized the importance of data dependence in decision-making, indicating that policy adjustments will be made in response to new information.
Analysts at Bank of America predict no changes to rates or guidance in the ECB’s statement. However, they anticipate Lagarde signaling increased confidence in reaching the 2% target, albeit not sufficient to warrant rate cuts at this time.
Market expectations suggest a 25 basis points rate cut by the ECB in June, with little resistance from central bank officials. The focus for investors lies in the pace of rate reductions beyond June. Nomura forecasts a reduction of 125 basis points in 2024, bringing the deposit rate to 2.75% by December.
Senior economist Shaan Raithatha from Vanguard shares a similar outlook, foreseeing 125 basis points of rate cuts this year. However, he cautions that the pace of cuts may slow due to rising energy prices.
A faster pace of rate cuts could benefit European bonds and stocks but may negatively impact the euro, particularly against the U.S. dollar. The euro experienced a 1% decline following hotter-than-expected U.S. inflation data, with the yield gap between U.S. and German 5-year bonds reaching its highest level since late October.