Attention shifts to ECB as U.S. CPI weakens case for bigger Fed rate cuts

European stock markets were mixed following the release of US inflation data on Wednesday as investors reassessed the Federal Reserve’s (Fed) next interest rate decision and focused on the European Central Bank’s (ECB) interest rate announcement due later today.

On Wednesday, the Euro Stoxx 600 index ended flat after fluctuating throughout the session, while the DAX ended higher.

The euro came under pressure against the US dollar as yields on major European government bonds fell while U.S. Treasury yields rose slightly.

In contrast, tech stocks rose on Wall Street and so did the US dollar, with futures expected to open higher across Europe today as a result of this rally.

US inflation cools, failing to reach ideal target level

U.S. consumer prices rose 2.5% year-on-year in August, down from 2.9% in July and in line with expectations. This was the lowest annual inflation rate since February 2021.

However, core inflation, which excludes food and energy, rose 0.3% from July, beating the forecast of 0.2%, and bringing the annual increase to 3.2%, as expected.

These figures make it less likely that the Federal Reserve will cut interest rates by half a percentage point at its Sept. 17-18 policy meeting.

The market is now pricing in a 0.25 percentage point cut, rather than the 0.5 percentage point cut expected a month ago.

The likelihood of a quarter-point cut has risen to 85% from 50% in August, according to the CME FedWatch tool.

ECB likely to take a hawkish stance with rate cuts

At the same time, the European Central Bank (ECB) is widely expected to cut interest rates by 0.25 percentage points for the second time this year at its next meeting.

But the bank is likely to be cautious about any future actions and warn of a possible resurgence in inflation, especially after a slight increase in U.S. core inflation.

Eurozone consumer price inflation slowed to 2.2% in August, the smallest increase since July 2021, according to preliminary figures.

But core inflation remained steady at 2.8%, similar to that in the U.S. The sharp decline in annual inflation was partly due to a higher base last year.

Eurostat stressed that “the slowdown is due to base effects that emerged in August and led to a sharp fall in energy costs.”

Impact on the euro and European stocks

Market reaction to the US Consumer Price Index data revealed that investors are becoming cautious about the central bank’s future policy stance.

Key European indicators have been relatively flat this week, suggesting fading optimism about deeper interest rate cuts and rising expectations of a more hawkish stance from the ECB.

Further declines in European markets are expected if the ECB signals slower than expected progress in cutting interest rates.

EUR/USD hit a 13-month high of nearly 1.12 in late August but fell to 1.10 by early Asian time today.

The euro’s recent rise against the U.S. dollar lost momentum in September, suggesting the Federal Reserve may be taking a more hawkish stance than previously expected.

This could cause the euro to weaken against the dollar this month.

Additionally, the pound fell following disappointing UK GDP data on Wednesday.

The British economy stagnated for a second consecutive month in July, potentially prompting the Bank of England to continue cutting interest rates for the rest of the year.