Euro stays on the back foot as ECB rate decision approaches

• A deposit rate of 2.50% is expected to remain in place when the ECB meets on Thursday.
• With energy costs fuelling price pressures, investors continue to price in the possibility of a central bank rate rise in December.
• The ECB’s assessment of inflation risks and growth, alongside its guidance on monetary policy, is keenly awaited by markets.

Following the Federal Reserve’s (Fed) decision to leave interest rates unchanged, the US Dollar (USD) is recovering from the previous day’s losses, weighing on EUR/USD. The pair trades around 1.1140 in Thursday’s Asian session, retreating after modest gains a day earlier.

Interest rates were left at 3.75%–4.00% by the Federal Reserve, which said economic activity was still expanding. Resilient domestic spending, solid capital investment and strong productivity growth featured in the Fed’s statement. On the employment side of its mandate, the central bank noted that job creation had matched workforce growth, with little movement in the unemployment rate.

Although the Fed recognised that inflationary pressures remained elevated, it opted to suspend further rate rises while collecting more data and judging the appropriate stance of monetary policy. There were two dissenting votes: Fed Governor Lisa Cook and Cleveland Fed President Beth Hammack both favoured an immediate increase.

With the underlying economy still strong, Fed Chair Kevin Warsh reiterated the Federal Open Market Committee’s commitment to price stability and its 2% inflation goal. Turning to the future policy calendar, he said the Fed would convene eight meetings next year—including one without a formal vote—and that he expected six policy-setting meetings in 2028.

Expectations that the European Central Bank (ECB) will leave its deposit rate at 2.50% on Thursday are weighing on the Euro (EUR), after rate rises totalling 50 basis points earlier in the year. Yet continued energy-led inflation has kept open the debate over a possible further increase in December. Investors are therefore scrutinising the ECB’s assessment of inflation risks and economic growth, together with any signals about the future path of interest rates.

Euro credit conditions tighten modestly while ECB policy transmission remains smooth

Recent policy changes have had only a limited effect on credit conditions, according to Danske Bank analysts’ reading of the ECB’s Q3 Bank Lending Survey. As they put it, “banks tightened credit standards more than expected, although the net share reporting a tightening remained low from a historical perspective and was mainly driven by banks in France.” For Danske, the findings “suggests that the ECB's tightening has so far only led to a modest tightening of credit standards and should not in itself stop the ECB from tightening further as the pass-through remains relatively smooth.”