ECB Preview: no doubt about a cut, but 25 and 50 are both valid.

The European Central Bank (ECB) is set to cut rates for the fourth time this year when they meet on Thursday. Market consensus heavily leans toward a 25-basis-point cut, with an 85% probability compared to a 15% chance of a larger 50-basis-point reduction. The ECB has been trying to get ahead of the curve in order to avoid excessive easing at a later date and, whilst a 50-basis point cut will be considered, it is likely that President Lagarde and her team opt for a smaller 25 bps cut. The central bank fears falling into negative rates territory, but the easing cycle is likely to be gradual. 

Gradual Easing Likely

Lagarde has consistently emphasized that monetary policy will remain "sufficiently restrictive" for as long as necessary. The critical question is how long that stance will hold. While disinflation has been a prevailing trend across much of the Eurozone over the past year, recent upticks in the consumer price index and weakening confidence indicators since October underscore the growing threat of stagflation.

Mounting Risks in the Eurozone

The Eurozone faces significant headwinds. Political instability, particularly in France and Germany, adds to economic uncertainty, while potential adverse effects from U.S. economic policies loom as Donald Trump begins his term. Acknowledging these challenges, the ECB’s forecast for its terminal rate in 2025 is notably lower than those of the Federal Reserve or the Bank of England. This reflects the bank's urgency to stimulate growth sooner rather than later.

Balancing Act: Risk Management vs. Market Confidence

A 50-basis-point cut could serve as a risk management strategy to pre-emptively address economic fragility. However, such a move might signal heightened concerns about growth, potentially alarming markets. This could exacerbate rate differentials, putting additional pressure on the euro. EUR/USD and EUR/GBP appear particularly vulnerable, as both the Fed and BOE are expected to implement fewer cuts over the next year.

To avoid spooking investors, the ECB will likely proceed with a 25-basis-point cut, leveraging Lagarde's press conference to reassure markets of its commitment to staying ahead of the curve. She may hint at the possibility of larger cuts in the future if conditions worsen. Such communication would likely temper market reactions.

EUR/USD daily chart

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