European Central Bank Preview: ECB expected to hold interest rates for first time in current tightening cycle

• The European Central Bank is set to keep key interest rates steady on Thursday after ten consecutive hikes.
• ECB’s Lagarde could strike a hawkish tone amid upside risks to inflation on Middle East strife.
• The Euro volatility will likely spike up on the ECB decision and Lagarde’s presser.

Ten meetings later and after an unprecedented 450 basis points increase in interest rates in less than two years, the European Central Bank (ECB) is set to keep borrowing costs steady on Thursday. The decision will be announced at 12:15 GMT, followed by ECB President Christine Lagarde’s press conference at 12:45 GMT. There will be no publication of the updated staff projections at this meeting.

European Central Bank interest rate decision: What to know in markets on Thursday

• EUR/USD is sitting at the lowest level so far this week near 1.0550, courtesy of risk aversion fueled by Mideast tensions and surging US Treasury bond yields. 
• The benchmark 10-year US Treasury bond yield is closing in on the 5.0% level yet again, 
• In a televised statement late Wednesday, Israeli Prime Minister Benjamin Netanyahu said that Israel is preparing a ground invasion of Gaza.
• US S&P 500 futures trade with sizeable losses, as a result of global flight to safety. 
• Germany’s IFO Business Climate Index for October came in higher than expected at 86.9 on Wednesday, beating the market forecast of 85.9. This was the first monthly increase after five consecutive declines.
• On Tuesday, HCOB's flash Eurozone Composite Purchasing Managers' Index (PMI), compiled by S&P Global, fell to 46.5 in October from September's 47.2, its lowest since November 2020. 
• The ECB event is expected to provide a fresh directional impetus to the EUR/USD pair, with attention turning toward next week’s Fed policy announcements.

What is expected from the next ECB meeting and how will it impact EUR/USD?

Economists are widely expecting the European Central Bank (ECB) to announce a  pause on Thursday, keeping the Deposit Rate steady at 4% while maintaining the Refinancing operations lending rate at 4.5%.

Despite a steady interest rate decision, markets are betting on a hawkish message from ECB President Christine Lagarde at the press conference, keeping hopes alive for an interest rate hike in December. Renewed geopolitical threat, emanating from the Hamas-Israel military conflict, poses upside risks to the Eurozone’s inflation outlook, which could make it difficult for the central bank to reach its 2.0% target by end-2025, as previously projected. As a net energy importer, the region is directly impacted by rising Oil and Gas prices amidst escalating Middle East tensions.

However, the debate for the next interest rate hike is for the December policy meeting. For this week’s gathering, ECB policymakers could discuss the non-interest rate monetary policy tools, including minimum reserves, reversed tiering and a possible earlier unwinding of the reinvestment of bond purchases under the Pandemic Emergency Purchase Programme (PEPP).

Last month, Reuters reported, citing six sources, that ECB officials “want to soon start discussing how to tackle the multi-trillion-Euro pool of excess liquidity sloshing around banks, with raising reserve requirements a possible first move.”

But the central bank could refrain from tightening financial conditions further, as they assess the lag effect of their interest rate hikes on the economy and inflation prospects. The central bank for over 20 countries that use the Euro has already raised interest rates 10 times to record levels, increasing stagflation risks. 

Eurozone’s annual inflation fell to 4.3% in September, cooling to its lowest level since October 2021. The contraction in the Eurozone business activity deepened in October, a survey showed, suggesting the old continent could slip into recession. These data supported the case for an ECB pause on Thursday.

Analysts at BBH noted: “European Central Bank meets Thursday and is expected to keep rates steady.  While there are still a handful of hawkish holdouts, most ECB policymakers have acknowledged that the tightening cycle is over.”

“The bank is expected to discuss modifications to reserve requirements as well as how to shrink its PEPP holdings but no decisions are expected until next year. Updated macro forecasts won’t come until the December 14 meeting. Of note, WIRP suggests no odds of a hike this week, rising to top out at only 10% for December 14. A rate cut is nearly priced in for June 6,” BBH analysts added.

If the ECB holds rates and President Lagarde delivers a hawkish message, leaving the door ajar for a December rate hike, EUR/USD could extend its recovery toward 1.0800.  On the contrary, an ECB pause combined with a dismissal of potential upside risks to inflation expectations could be viewed as a dovish pause. In this case, the EUR/USD pair could resume its downtrend toward 1.0500.

Dhwani Mehta, Asian Session Lead Analyst at FXStreet, offers a brief technical outlook for the major and explains: “EUR/USD has breached the short-term critical 21-day Simple Moving Average (SMA) on its three-day downtrend that extends into Thursday. The 14-day Relative Strength Index (RSI), however, is pointing lower below the 50 level, indicating that downside risks remain intact for the pair.”

Outlining important technical levels to trade the EUR/USD pair, Dhwani notes: “The immediate support is aligned at the previous week’s low of 1.0511. A sustained break below the latter will put the focus back on the multi-month trough of 1.0448. The last line of defense for Euro buyers is seen at the 1.0400 round level. Conversely, buyers need acceptance above 1.0600 to revive the uptrend toward the 50-day SMA at 1.0665. The next topside target is pegged at the 1.0700 threshold.”