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ECB’s refusal to turn dovish supercharges EUR/USD rally

Roman Ziruk, Matthew Ryan, CFA

The tone of the last ECB meeting of the year was noticeably more hawkish than expected by markets, allowing EUR/USD to extend its rally on Thursday.

The ECB’s statement included a small dovish tweak, as the bank dropped the mention of inflation being ‘too high for too long’. That said, other signals from the December meeting more than balanced out this little edit. As we anticipated, the tone of the bank’s communication on growth was not overly pessimistic, nor were the comments on inflation overly positive. The communications were clearly toned-down and, above all, struck a balanced tone. The risk assessment was not too different from October and the revisions to the bank’s economic projections were rather limited, for the most part, and mostly in line with expectations.

Slower growth

The bank is now pencilling in marginally slower growth of 0.6% this year (down from 0.7%), and 0.8% in the following year (from 1%), with expansion expected to accelerate to 1.5% in 2025 and 2026. Meanwhile, the ECB’s inflation projections saw slightly larger revisions, particularly with regard to 2024, when the bank projects price pressures to ease to 2.7% (from 3.2%). In the longer-term, the bank sees inflation declining to target, with the newly added 2026 projection pointing to headline price growth of 1.9%.

The Governing Council acknowledged the progress made on inflation, which will certainly be a welcome development, although it appears to be signalling that the ‘last mile’ in the inflation fight could still be challenging. Policymakers placed a particular emphasis on the state in the labour market, saying that strong growth in unit labour costs was acting to keep domestic price pressures elevated.

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: ECB Inflation Projections [December 2023]


During her press conference, President Lagarde struck a largely hawkish tone. She stressed data-dependence and mentioned that the bank should not lower its guard, despite recent signs of progress on inflation, which is clearly a hawkish signal. She also explicitly noted that the council did not discuss interest rate cuts during this week’s policy meeting. This further supports the notion that the goal of the meeting was to provide a neutral, watered-down message that effectively kicks the can down the road.

As a side note, the ECB announced its timetable for ending reinvestments under the Pandemic Emergency Purchase Programme (PEPP). Full reinvestments of principal payments will end in mid-2024, and the portfolio will shrink by €7.5 billion per month on average through to the end of 2024, when reinvestments will conclude. This could be seen as yet another hawkish signal, although Lagarde herself downplayed the move, calling it a ‘balance sheet normalisation’, while stressing that the PEPP and interest rate decisions are two separate things.


The cautious, balanced and somewhat hawkish communications from today’s ECB meeting clearly contrasts with the bold dovish signals we received from the Federal Reserve on Wednesday. This rather sharp divergence across the Atlantic has left us scratching our heads a bit, particularly as economic conditions appear to favour a more aggressive easing bias from the ECB, more so than the Fed.

Following the announcement, EUR/USD jumped by more than half a percent, extending its gains following Wednesday’s thoroughly dovish Fed communique, and sending the pair just shy of the 1.10 level, its strongest position in two weeks. Leading into the meeting we signalled that risks to the common currency were titled to the upside given the aggressive market pricing for ECB cuts in 2024 – pricing that was ramped up following yesterday’s dovish turn from the Fed. The hawkish undertones of the ECB’s communications was clearly unexpected by markets, and have left many investors wrong-footed.

EUR/USD 1 week

Market expectations for Euro Area rate cuts have decreased slightly since today’s ECB meeting. At the time of writing, investors expect approximately 140 basis points of cuts next year, versus the 150bps seen earlier in the day. We continue to see these expectations as too aggressive, and today’s communication supports our view that cuts remain some way off. Swaps see the first reduction in rates in March (60% priced-in), but we remain of the opinion that this could be too soon given our view that the ‘last mile’ of the inflation fight will likely prove challenging, and that the ECB has a penchant for approaching rate changes in a cautious manner.


Author EFI

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