If the European Bank's stance turns dovish, be wary of further pressure on the euro!

Thursday's European Central Bank policy meeting could bring more good news for the euro, according to analysts who see a slowing economy and easing inflation as reasons to believe a rate rise in July will be the last.

The European Central Bank pre-promised at its June meeting that it would raise interest rates again in July, meaning the decision to raise rates would not have a significant impact on markets, butThe change in guidance for a September rate hike could trigger foreign exchange volatility。

Valentin Marinov, head of G10 FX strategy at Cre ́ dit Agricole, said: "We stand by our view that the euro has absorbed too much positive news given the increasingly difficult domestic situation.If the European Central Bank ultimately lacks a hawkish tone on Thursday, that could force some euro bulls to clear out。"The euro is one of the outperforming FX currencies in 2023 due to improved economic sentiment as the energy shock fades in 2022 and ECB rate hikes boost the attractiveness of eurozone assets. With a further 25 basis point hike this Thursday, ECB deposit rates will rise to 3.75% and MRO to 4.25%.

The rate decision comes after we saw the euro's trade-weighted index, a broader measure of the euro's performance against a range of currencies, near record highs. But official data suggest the eurozone economy is in fact in recession, with data confirming two consecutive quarters of contraction. And July's PMI showed no improvement in the outlook for the eurozone economy at all, with the PMI firmly in contraction territory.

Brian Martin, head of G3 economics at ANZ, said: "The eurozone economy is reeling from a combination of high inflation, rapid interest rate rises, weak global trade, geopolitical risks and the energy transition."Eurozone inflation is falling, indicating that the peak has arrived and raising the question of whether further interest rate hikes are necessary。

Henry Allen, an economist at Deutsche Bank, said:Markets continue to lower the likelihood of another rate hike following Thursday's rate decision, with a 75% chance now compared to 88% last weekend.ButWith a 75 per cent chance that markets (and the euro exchange rate) remain confident of a September rate rise, the euro could fall further if these expectations weaken further after the ECB's July meeting.

"We do believe this rate hike will mark the end of the rate hike cycle, with peak rates stabilising at 3.75 per cent," said a report from the rates strategy team at NatWest Bank Markets. "Inflation data are softening and growth data continue to weaken. The ECB is expected to repeat the main points of the statement to avoid an overly strong market revaluation."

Jamie Dutta, market analyst at Vantage, said weaker headline inflation and "this week's shockingly weak PMI data are likely to cast doubt on the ECB's more bullish macro forecasts in the near term", saying the weak growth outlook would challenge all hawks whose main focus is on high inflation.

One of the hawks, Klass Knot, said last week,The September rate hike is not on the board, which amounts to a clear signal that the European Central Bank may consider pausing rate hikes。

Of course, if the data allows, the guidance will almost certainly maintain the possibility of further rate hikes, but it will lack the strong forward guidance from previous meetings.

Mr. Dutta said: "It seems sensible for the ECB to emphasise a data-dependent, meeting-after-meeting stance. Lagarde, who is reluctant to commit, should probably also be advised to take a'less is more 'approach. By the next meeting in mid-September, the ECB will have a series of economic data and updated staff forecasts."

The extent to which the ECB views this shift to data dependence as a "dovish" turn will determine the extent to which the euro responds。

Dutta said: "If the ECB's stance turns dovish on Thursday, the euro will continue to be under pressure。”

ANZ's Martin believes the expected rate rise could be the last of the current cycle, as he estimates the ECB's current level of interest rates is consistent with a return to inflation to its target of 2.0 per cent within the forecast range. Martin also said: "While there is a risk that the ECB may need to raise rates further, the rapid rate rises of the past 12 months must give time to work. The rate hike cycle should no longer follow a pre-set course."

EUR/GBP daily chart

At 13:53 on July 27, Beijing time, the euro was trading at 0.8565/66 against the pound.