**FX Outlook: Key Takeaways from UBS on ECB and EUR/USD**
*By eFXdata*
**Introduction**
The forex market is facing a critical juncture as major central banks signal the next phase of monetary policy. The European Central Bank (ECB) stands in the spotlight, with market participants eager to decipher the institution’s evolving reaction function. UBS recently released an analysis of the ECB’s path, examining its policy signals, economic projections, and the likely trajectory of the euro. This article brings together the key points, insights, and implications of UBS’ assessment, arming currency traders with the knowledge needed to navigate the volatile environment.
**ECB’s Dilemma: Rate Adjustments against a Mixed Backdrop**
The ECB, like its developed market peers, is tasked with balancing economic recovery against the uncertainty of inflation. The recent ECB meeting, as reviewed by UBS, was notable for a policy rate cut and nuanced communication on future guidance.
**Core Observations from the ECB Meeting:**
– The ECB delivered a 25 basis point rate cut, the first in over five years.
– The accompanying statement maintained a cautious stance, emphasizing data dependency.
– ECB staff revised their CPI forecasts upward, reflecting concerns over lingering inflationary pressures.
– Growth projections remained subdued, with the bank acknowledging ongoing weakness in industrial sectors and labor markets.
UBS interprets the ECB’s market message as a commitment to flexibility. While the first cut was clearly telegraphed, subsequent moves are less certain, dependent on data flow over the summer months.
**Three Pillars to ECB Policy Making**
UBS highlights three critical variables shaping the ECB’s guidance and action:
1. **Inflation Dynamics**
– Headline and core inflation signals remain the central focus.
– UBS notes that while goods inflation is moderating, services prices are sticky.
– Wage growth acceleration continues to underpin price pressures.
– Staff forecasts see inflation returning close to, but not below, the ECB’s 2% target by 2025.
2. **Economic Activity**
– Surveys and hard data point to patchy growth in the eurozone.
– The labor market is showing early cracks, with UBS warning of potential layoffs if activity does not rebound.
– Manufacturing and construction sectors remain notable weak spots.
3. **External Developments**
– The global landscape is fraught with risk, including US-China trade uncertainties and ongoing conflict in Ukraine.
– Currency volatility, particularly in EUR/USD, poses an additional challenge to policy calibration.
These pillars underscore the ECB’s reluctance to pre-commit, leaving the policy path open-ended.
**UBS’s Rate Path Projections**
After dissecting ECB communication and the macro backdrop, UBS lays out its expectations for the rate path:
– UBS expects further rate cuts, but at a measured pace.
– The next move is likely to be postponed until September, not July, absent a shock in the data.
– Market pricing suggests a total of two to three cuts in 2024, with the deposit rate reaching 3% by year-end.
– Risks are skewed toward fewer cuts if inflation proves stickier than ECB projections.
The implication for eurozone yields and the EUR itself is that policymakers will remain watchful, avoiding a dovish overshoot that might further weaken the currency and import inflationary pressures.
**EUR/USD: Outlook and Catalysts**
UBS devotes significant attention to the implications for EUR/USD, recognizing the pair as a bellwether for global macro and risk sentiment.
**Key Factors Impacting EUR/USD:**
– The narrowing gap in policy rates between the ECB and the Federal Reserve will be gradual. The Fed is not expected to cut until later in the year.
– Political risk, particularly around the European Parliament elections and possible surprises from US politics, could trigger short-term volatility.
– Technical resistance for EUR/USD is observed in the 1.0900-1.1000 area, with support
Read more on GBP/USD trading.