European markets may be bracing for a hawkish rate cut from the European Central Bank, following higher-than-expected US inflation data, which dampened hopes for a significant rate reduction by the Federal Reserve.
ADVERTISEMENTEuropean stock markets displayed mixed movements following the release of US inflation data on Wednesday, as investors reassessed the Federal Reserve's (Fed) next interest rate decision and turned their focus towards the European Central Bank's (ECB) upcoming rate announcement later today.
On Wednesday, the Euro Stoxx 600 index ended flat after fluctuating throughout the session, while the DAX closed higher.
The euro came under pressure against the US dollar as major European government bond yields declined, whereas US Treasury yields edged upwards.
In contrast, Wall Street saw a tech-driven rally, alongside a rise in the US dollar. Following the rally, futures point to a higher open across Europe today.
Cooling US inflation fails to reach ideal target level
In August, US consumer prices rose 2.5% year-on-year, down from 2.9% in July, aligning with expectations. This marks the lowest annual inflation rate since February 2021.
However, core inflation, which excludes food and energy, increased by 0.3% from July, higher than the anticipated 0.2%, resulting in a 3.2% annual rise, matching forecasts.
These figures have reduced the likelihood of a 0.5% rate cut by the Federal Reserve at its 17-18 September policy meeting.
Markets are now pricing in a quarter-point rate reduction instead of the half-point cut expected a month ago.
According to the CME FedWatch Tool, the probability of a quarter-point cut has risen to 85%, up from 50% in August.
ECB likely to signal hawkish stance with rate cut
Simultaneously, the European Central Bank (ECB) is widely expected to implement its second 0.25% rate cut this year at the upcoming meeting.
However, the bank is likely to adopt a cautious tone regarding future actions, warning of the potential for inflation to resurge, especially following the slight rise in US core inflation.
According to flash estimates, Eurozone consumer price growth eased to 2.2% in August, marking the slowest increase since July 2021.
However, core inflation, as in the US, remains persistent at 2.8%. The sharp decline in annual inflation can also be attributed in part to a higher base last year.
Eurostat highlighted that "the slowdown was due to a sharp fall in energy costs as base effects came into play in August".
Implications on the euro and European stocks
The market reaction to the US CPI data revealed that investors have become cautious about the future policy paths of central banks.
ADVERTISEMENTMajor European benchmarks have remained relatively flat this week, suggesting that optimism for substantial interest rate cuts has diminished, with expectations now shifting towards a more hawkish stance from the ECB.
A further decline in European markets could be anticipated if the ECB signals slower-than-expected progress on rate cuts.
The EUR/USD pair hit a 13-month high of nearly 1.12 in late August before retreating to 1.10 in the early Asian session today.
The euro's recent rise against the USD has lost momentum in September, indicating that the Federal Reserve may be adopting a more hawkish stance than previously anticipated.
ADVERTISEMENTThis could result in a weaker euro against the dollar this month.
Additionally, sterling weakened following disappointing UK GDP data on Wednesday.
The UK's economy stagnated for the second consecutive month in July, which could prompt the Bank of England to continue its rate cuts for the remainder of the year.
