ECB set to be first to cut interest rates

The ECB has strongly hinted at a rate cut in June, and markets have nearly fully priced it in. However, it is probable that the Fed and BoE will delay their initial rate cuts, thereby leaving the ECB in a somewhat isolated position.

These factors are exerting downward pressure on the euro. Additionally, concerns regarding higher oil prices and tensions in the Middle East are contributing to the unease.

Stock markets in the US are aiming for a recovery on Thursday after enduring a downward trend throughout the week. The downward trend has been fueled by concerns over a potential escalation between Israel and Iran, as well as by Fed Chair Powell's shift in stance, acknowledging the possibility of extended periods of high interest rates.

The ECB may be concerned about the weakness of the euro, especially considering its clear intentions to cut rates in June.

Given the likelihood of the Fed maintaining steady rates over the summer, and the BoE facing no immediate pressure to cut rates following this week’s employment and CPI data, the ECB may find itself at the forefront of initiating an easing cycle.

This situation may cause concern for them as it could evoke memories of early 2022, when members were slow to acknowledge the inflation threat and were the last to begin hiking rates. Their dovish stance and delayed response eroded credibility and contributed to EURUSD falling below parity to a low near 0.95.

Two years later, the ECB seems poised to lead the way in departing from its dovish stance and reintroducing rate cuts, despite persistent inflation and signs of recovery in the US. Doves may argue that the situation in the US differs significantly from that of the EU, with much stronger data. However, the reality is that inflation and disinflation trends in the US have influenced those in the EU. This implies that the disinflation trend in the EU could decelerate and even reverse just as the central bank is solidifying plans to cut rates.

Therefore, the ECB is potentially teetering on the edge of another policy mistake, which could further diminish trust and drive euro prices even lower.

Higher oil prices played a significant role in the euro's depreciation in 2022. EURUSD is particularly sensitive to changes in oil prices due to the US being energy independent, while the EU heavily depends on imports. Recent tensions in the Middle East have disrupted supply lines, resulting in a recent surge in crude oil prices, which reached a 2024 high of $87 per barrel earlier this month. Although still below the levels seen in 2022, the overall situation and sentiment have notably improved in 2024. Thankfully, the energy crisis stemming from the Russia/Ukraine conflict has mostly been resolved.

Primarily, the weak euro is attributed to policy divergence and the anticipation that the ECB will cut rates several months ahead of the Fed. This could result in a continued decline in EURUSD, although it may not be as prolonged as seen in 2022.

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