In the first half of 2024, the euro's nominal effective exchange rate was virtually unchanged, depreciating nearly 3% against the US dollar (the dollar index rose 4.4% over the same period) and nearly 1% against the Chinese yuan. Most institutions believe that the euro will continue to fall against the dollar in the second half of the year because the timing of the Fed's rate cut is still uncertain. In addition, the increased political uncertainty in the EU is expected to significantly increase the volatility of the euro exchange rate.
The main reasons for the euro's decline against the dollar in the first half of the year were the European Central Bank's first interest rate cut in nearly five years in early June, ahead of the US Federal Reserve, and the sudden snap French parliamentary elections, which raised concerns about the stability of the euro.
Investors still expect a rate cut in the euro in the second half of the year
Despite the ECB's scheduled interest rate cut in early June, there are signs that this is not the start of a traditional rate-cutting cycle. ECB President Christine Lagarde has repeatedly stressed that interest rate cuts will not be carried out in accordance with the schedule of interest rate meetings, but will be decided according to changes in the data. Without a more positive contribution from Labour costs and corporate profits to falling inflation, the ECB is likely to keep rates on hold at more than one monetary policy meeting.
Eurostat data show that eurozone consumer price inflation has reversed since bottoming out at 2.4 per cent in November, with service sector price growth, driven mainly by rising wages, accelerating in particular.
In this regard, the European Central Bank's chief economist Philippe Laing pointed out that the monthly inflation data should not be too sensitive, and cost pressures will abate next year. The ECB is highly confident of achieving its 2% inflation target, but retains flexibility on the exact timetable for achieving it.
But he also acknowledged that some eurozone countries had seen a sharp rise in wages. Further ECB action would need to see a reduction in inflation momentum in the services sector. "One way to deal with uncertainty is to wait a while" to ensure there are no policy back-and-forth.
One in 12 containers worldwide is now stuck in traffic jams, according to a study published last week by Commerzbank, pushing up freight rates on routes from China to Europe in particular. It is estimated that it could raise core inflation in the euro area by about 0.25 percentage points. Given the sharp rise in wage costs, core inflation is likely to stabilise at 3% over the next year, well above the ECB's 2% target.
Reports from the European Central Bank show that the near end of the overnight index swap forward curve, based on the euro short-term interest rate STR, reflected market participants' interest rate cut expectations (65 basis points) in early June, compared with March (100 basis points). In other words, after the ECB first cut interest rates by 25 basis points, professional investors expect another 1-2 rate cuts during the year.
In contrast, the market-priced probability of a Fed rate cut is now slightly above 50% in September, and many investment banks expect the first rate cut in the United States may not be until December or even early next year.
At its monetary policy meeting in mid-June, the Fed projected one rate cut this year, compared with three at the previous meeting.
The International Monetary Fund has also warned the Fed in recent days not to cut rates too soon. It believes the Fed should keep its key interest rate at its current level until at least the end of 2024. The IMF is even more optimistic about US inflation than the Fed.
As a result, short-term spreads between the euro area and the United States are far more likely to widen or stay flat in the second half of the year than to narrow.
