Euro: ECB guidance may trigger asymmetric downside risks - Commerzbank

Commerzbank’s Antje Praefcke notes that markets are fully pricing an European Central Bank (ECB) rate hike next week after Euro Area inflation rose to 3.3%, but she doubts further tightening beyond September as projections show inflation declining into 2027. She argues EUR upside is limited and warns of an asymmetric downside reaction if the ECB signals an end to its hiking cycle.

ECB path key for Euro reaction

"By yesterday at the latest, it should have become clear even to the last person: the ECB will raise its key interest rate once again next week. The fact that inflation in the euro area rose to 3.3% year-over-year in August clearly points in that direction."

"It is irrelevant that the spike in the inflation rate was primarily caused by the resurgence of the Middle East conflict - and thus by the renewed rise in energy prices - and that the core inflation rate actually fell slightly, surprisingly"

"The market even sees a chance that the ECB will continue its rate-hiking cycle, as it is pricing in the possibility of another rate hike by early next year."

"We are, however, more skeptical in this regard, as inflation is likely to fall again next year, so our experts do not expect any further hikes after September. Especially since the current ECB projections also show inflation declining over the course of 2027."

"Since the market is already pricing in next week’s rate hike, this is likely to provide only limited upside potential for the euro. Rather, it will be more important whether the ECB fuels expectations of further tightening next week - whether through its statements or new projections - or whether an end to the cycle is in sight."

"However, if it becomes apparent at the meeting that no further hikes are coming - as our experts expect - the euro is likely to lose ground. Since the market has to adjust more to the latter, I would expect an asymmetric reaction, meaning that the euro is likely to suffer more strongly on a disappointment of current market expectations."

"If the ECB continues to fuel expectations of interest rate hikes through its statements and new inflation forecasts, the euro could gain a little more ground."

(This article was created with the help of an Artificial Intelligence tool and reviewed by an editor. Know more.)