What will the ECB decide on interest rates?

Today's decision European Central Bank on interest rates. We should not expect changes in the parameters of monetary policy. The market is wondering whether it will learn more than what the bank's president and her colleagues said last week in Davos.

We know one thing for sure, further decisions will depend on data. At this point the market gives about 50 percent. chances for a reduction in the cost of money in April and fully estimates the mid-year reduction.

Don't make a mistake

In December, the ECB quite clearly announced the end of the rate hike cycle. Financial markets took this signal and the current economic weakness as clear signs of impending rate cuts.

What we can be sure of now is the ECB's willingness to suppress expectations of rate cuts, which have already gone too far. Long-term bond yields have risen since December lows, but they are there far removed from their peaks last fall. This eases financing conditions to some extent and at the same time weakens the effect of restrictive monetary policy to some extent. The Governing Council wants to be sure that inflation is on track and will be achieved within the forecast horizon before taking the first easing steps.

Most central banks do not want to make the mistake of deciding to cut too early. The ECB and other institutions care about their good image, transparency and credibility. If they made a move that had not previously been communicated in any way, then market confidence could be damaged. An even worse scenario would be a premature reduction, an increase in inflation in the following months and then an increase in rates aimed at combating the second wave of this economic phenomenon.

What are the forecasts for the euro exchange rate?

In the case of inflation, the ECB's job has not yet been done. It is true that it is decreasing, but reaching the designated level of 2%. can be a long process for several reasons. In the coming months, the development of price growth dynamics will be determined by two opposing trends.

On the one hand, we will have greater disinflation as a result weaker demand resulting from the economic slowdown. In turn, inflationary pressure may appear due to less favorable base effects, rising wages and as a result of tensions in the Middle East. If the geopolitical situation escalates, there is a risk of oil prices rising and rising again CPI indicators. Government interventions in some countries, especially Germany, will be important.

Against this background, where the risk for inflation is greater rather than less, whatever cutting interest rates at this stage makes no sense, at least not in the eyes of the ECB.

If Christine Lagarde effectively limits market expectations for rate cuts, the euro may benefit from this change and lead to further increases in the main currency pair, at least to the level of 1,10.

Source: Łukasz Zembik, OANDA TMS Brokers