Mikkel Rosenvold
3 weeks ago

Will Europe cut rates before US?

Analyst Ulrik Simmelholt from Steno Research argues that the ECB should initiate rate cuts without fearing wider real rates spread with the USD, emphasizing the importance of commodity prices and energy dependencies over monetary policy in determining Euro strength.

Ulrik Simmelholt of Steno Research argues that the European Central Bank (ECB) should not hesitate to cut interest rates, despite fears of a widening real rates spread with the US dollar (USD). According to Simmelholt, manufacturing data and headline Harmonized Index of Consumer Prices (HICP) year-on-year in the Euro Area indicate a need for easier financial conditions. However, the ECB appears reluctant, preferring to follow the Federal Reserve's lead. Simmelholt contends that this fear is unfounded and presents three key arguments to support his case.

Firstly, Simmelholt asserts that the relationship between real rates and the EUR/USD exchange rate is not as straightforward as commonly believed. Historical data from the past decade shows that the EUR/USD can rise even when the real rates spread widens. Real rates are not the sole determinant of the EUR/USD path, and often, other macro factors play a more significant role. He suggests that the ECB should focus on other influences, such as commodity prices, rather than fixating on real rates.

Energy prices, in particular, are critical for the Euro's strength and inflation in the Eurozone due to Europe's energy dependencies. Simmelholt points out that cheap input prices benefit the manufacturing sector in major European economies, leading to increased circulation of Euros in the global trade system. He highlights the correlation between the Euro Area's trade balance and headline inflation, emphasizing that energy independence is crucial. European politicians' decisions to close nuclear power plants in Germany and gas fields in the Netherlands are perplexing given the region's sensitivity to energy prices.

Simmelholt argues that the ECB should prioritize reopening natural gas fields in the Netherlands over defending the currency with rate hikes. Energy volatility and its muted impact over recent years suggest that the EUR/USD exchange rate could exceed 1.11. He believes that maintaining contained energy prices in the Eurozone would allow the ECB to cut rates without triggering a significant decline in the EUR/USD.

The bottom line, according to Simmelholt, is that the ECB can cut rates without fearing a drastic drop in the EUR/USD, provided energy prices remain stable. He advises watching natural gas prices for clues on the Euro's direction rather than focusing solely on the ECB's decisions. Simmelholt predicts upcoming rate cuts in the Eurozone, supported by the latest data from the Indeed Wage Lab Tracker, which the ECB monitors closely. This data confirms a dovish path ahead for the ECB, even if the Federal Reserve and possibly the Bank of England refrain from cutting rates.

In summary, Ulrik Simmelholt's analysis suggests that the ECB should not be deterred by concerns over the real rates spread with the USD. Instead, it should focus on energy prices and other macroeconomic factors that significantly influence the Euro's strength and inflation dynamics in the Eurozone.


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