ECB Less Willing than Fed to Send Policy Easing Signals

In contrast to the ECB and the BoE, the SNB, in its recent monetary policy meeting, adopted a more transparent stance on inflation. President Jordan, in his post-meeting statement, asserted that "monetary conditions are sufficient, and there is no need to allude to any future changes in monetary policy." This assurance was reflected in the updated forecasts provided by the SNB. Despite the actual inflation at the beginning of the forecast period being 0.4 percentage points lower than the 2.0% projection three months ago, the entire forecast profile showed significant reductions in many quarters up to Q3 2026. From Q2 2025 onwards, the revised forecasts indicated a 0.3 percentage point decrease at 1.6%, and the calendar year averages for 2024 and 2025 were also 0.3 percentage points lower at 1.9% and 1.6%.

A potential return to a period of pronounced disinflation in Switzerland could prompt the SNB to shift its focus from inflation concerns back to the issues of excessively low inflation or deflation experienced prior to the 2020 pandemic. This risk was acknowledged by the SNB, which now sees inflation risks as balanced. Furthermore, the SNB confirmed that it is no longer emphasizing foreign currency sales as part of its monetary policy strategy. President Jordan emphasized the flexibility of the SNB, stating that adjustments to policy would be made as necessary to achieve price stability. This implies that, given the current trajectory, the SNB may revert to a strategy of addressing downside inflation or deflation risks. I’m interpreting this as an increased likelihood of a return to purchasing foreign currency for Swiss francs, possibly preceding actual interest rate cuts.

The SNB's foreign exchange reserve holdings have decreased by just over CHF 300 billion since the beginning of 2022, representing a significant element in the fight against inflation that is now winding down. Despite the more hawkish communications from the ECB, only about 75 basis points of rate cuts are currently priced in, considerably less than anticipated from the ECB. This situation is expected to limit the upside potential for EUR/CHF, particularly considering our perspective that the recent gains in EUR/USD are beginning to appear excessive.

The recent substantial gain for EUR/USD appears precarious in our assessment, with limited rationale for the European Central Bank (ECB) to maintain a more hawkish stance than the Federal Reserve. This market sentiment, driving a significant foreign exchange movement over the past two days, is a conclusion drawn by market participants. Detailed information from the ECB indicates a central bank not entirely convinced by the available evidence that inflation is experiencing a sharp decline. Our FX Focus publications from yesterday provide in-depth coverage of the ECB and the Bank of England decisions.

While it was expected that the ECB would sharply reduce its 2024 inflation projection (from 3.2% to 2.7%), the core forecast was only minimally reduced by 0.2 percentage points to 2.7%. Interestingly, the 2025 core Consumer Price Index (CPI) projection was raised by 0.1 percentage points to 2.3%. This appears puzzling to us, especially given the ECB's recent inaccuracies in forecasting over the past three months. These forecasts seemingly served as the basis for President Lagarde to convey a more cautious message regarding the outlook for monetary policy. In contrast to Federal Reserve Chair Powell, who acknowledged discussions about the timing of rate cuts next year, President Lagarde confirmed no such discussions occurred, justifying it by citing the absence of evidence of a "sustainable slowdown" in inflation. This implies potential room for a shift in the new year if evidence emerges of a continued inflation slowdown.

The ECB did announce the tiering of Pandemic Emergency Purchase Programme (PEPP) reinvestments in H2 2024, which may have contributed to the market perceiving it as less dovish than anticipated. However, this plan is six months away and subject to change based on circumstances. It does, however, open the possibility for earlier rate cuts in 2024, a potential outcome that may garner more attention in the coming weeks, particularly if inflation data continues to show signs of easing.

Currently, there has been a pronounced movement in relative yields, with the 10-year US-Eurozone spread dropping nearly 20 basis points in two trading days, along with a 20-basis point shift in the 2-year swap spread. I believe sustaining this movement will be challenging and suspect that year-end position adjustments could be reinforcing it. Unlike the Federal Reserve's more dynamic response on Wednesday, the ECB Governing Council, consisting of 26 individuals, makes significant pivots less likely. While I contend that the euro-zone inflation data justifies a more significant pivot, like the FOMC, I anticipate a clearer shift to take place over the coming months.

The current backdrop in the euro-zone and globally does not appear conducive to a sustained rally in EUR/USD. Although fundamentals as drivers through the Christmas and New Year period are typically unreliable, should this rally persist, I expect a reversal as we progress through Q1 next year. From a seasonal perspective, Q1 covers a six-week period that historically represents the worst time of the year for EUR/USD.

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