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Euro exchange rate – will the ECB's rate cut harm it? Europe on the verge of recovery

Euro exchange rate – will the ECB's rate cut harm it? Europe on the verge of recovery

created Daniel Kostecki23 May 2024

There is a common opinion that cutting interest rates by European Central Bank already in June (this is what the market is currently focusing on) may lead to a decline in the euro exchange rate, because interest rate disparity will decrease. This view is usually correct, but it is enough to look at the zloty exchange rate after September 2023, what it looks like now despite the rate cuts by the Monetary Policy Council. The difference in interest rates against USD or EUR has also decreased, and yet the zloty is systematically strengthening.

In addition to interest rates and inflation, growth rates may be important

In this puzzle of the impact of interest rates on the exchange rate, factors other than the disparity in currency interest rates must also be taken into account. As a rule, central banks cut interest rates when the economic situation in a given country is deteriorating, the prospects for GDP growth are fading and the economy needs to be stimulated. In such a situation, the country's currency not only becomes lower in interest rates, but also the country will begin to face a more difficult economic situation, which may discourage foreign capital from investing. This combination of factors may actually weaken the currency after the interest rate cut.

While the eurozone is in a completely different position, and the rate cut is to be related to their adjustment to lower than before inflation and may help to revive economic growth. This is also confirmed by the incoming data and forecasts for Germany and the entire euro zone.

PMI data helped the euro exchange rate

The HCOB Eurozone Services PMI was 53,3 in May 2024, unchanged from a near-yearly high in the previous month and roughly in line with market expectations of 53,5, according to preliminary estimates. This was the fourth consecutive increase in service activity, indicating some improvement in the sector despite heightened growth concerns due to the prolonged period of restrictive ECB policy. Also according to preliminary estimates, the euro zone manufacturing PMI rose to 2024 in May 47,4, the highest level in 15 months, from 45,7 in April and above market expectations of 46,2.

ECB rate cut at the perfect time?

It therefore seems that the ECB's interest rate cut may come at an ideal economic moment, supporting the recovery that has begun to smolder in the euro zone and Germany, which in consequence, instead of weakening the euro, especially against the dollar, may actually strengthen it, as if events on PLN from September 2023

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About the Author
Daniel Kostecki
Chief Analyst of CMC Markets Polska. Privately on the capital market since 2007, and on the Forex market since 2010.