EUR/USD drills lower as ECB cuts and US retail sales beats estimates

The European Central Bank has lowered the cost of money for the third time since June. The deposit rate has been cut again by 25 basis points, bringing it to 3.25%. Everything indicates that a similar adjustment should be expected in December. Investors, however, were more impressed by the fantastic retail sales data from the US. After an increase in the core index by as much as 0.7% month-over-month, it can be estimated that the US economy is growing at a rate of around 3.5%, which does not require further sharp cuts by the Fed. The EUR/USD exchange rate approached 1.08, reaching its lowest level in about 10 weeks.

When the ECB started its easing cycle in June, the deposit rate was at a record high of 4%. At the time, the baseline scenario was one 25-basis-point cut per quarter. Therefore, immediately after the September meeting, the deposit rate was expected to remain at 3.5% in October. However, there was no surprise in yesterday's move. In recent weeks, investors had fully digested the decision and market participants surveyed by Bloomberg unanimously expected it. The prevailing view now is that the ECB will seize every opportunity to cut rates through March, reducing the cost of money by a total of 75 basis points during that period.

Signals from the economy drove the shift in perception of the Governing Council's intentions. Sentiment indicators in both services and manufacturing paint a bleak, recessionary picture that demands action from monetary authorities. German industry is in particularly deep trouble, with GDP contracting 0.3% year-on-year in 2023. This year's economic growth has been disappointing, hovering around zero, though a few quarters ago, forecasts projected a result that was about half a percentage point higher. Accelerated rate cuts are not being hindered by price pressures. For the first time since mid-2021, consumer inflation in the eurozone fell below 2% year-on-year in September. The core inflation rate is also at cyclical lows (2.7% year-on-year).

Dark clouds over the eurozone and the sharp discounting of October's cut have restrained the EUR/USD pair's gains, even as the dollar was on the defensive. The main currency pair failed to break 1.12 by the end of the third quarter. After the Fed's intentions were reassessed and hopes for further sharp US rate cuts of 50 basis points were dashed, the euro-dollar dropped below 1.10. It's worth noting that the projected range of declines for the main currency pair after forming a so-called double top has now been nearly fully realized.

In the coming weeks, the US dollar is likely to remain strong, partly due to the upcoming presidential elections in the US. As the campaign reaches its final stages before the November 5th vote, Donald Trump's chances of returning to the White House and his protectionist trade practices, pro-inflationary economic policies, and geopolitical uncertainty appear to be growing. The Republican candidate's odds of winning are currently estimated at around 55%. In the longer term, the USD is expected to return to a downward trend due to the Fed's commitment to easing monetary policy. Meanwhile, the current market pricing of the ECB's near-term intentions may prove to be too aggressive, as proponents of a restrictive policy within the Governing Council are likely to resist overly rapid cuts.