The European Central Bank and the Bank of England are assessing the impact of a weakening US dollar and a surge in cheap imports on their inflation outlooks, with both expected to keep key interest rates unchanged this week.
According to market expectations, both the ECB and the BOE will announce their interest rate decisions on Thursday, February 5th, with forecasts pointing to no change in policy.
Markets are closely watching for the ECB's assessment of inflation, which has already fallen below its target, and the associated downside risks to growth. Meanwhile, the new quarterly forecasts and policy guidance from the BOE will be crucial for evaluating the likelihood of a rate cut starting in the spring.
The ECB has not adjusted borrowing costs since last June, and investors anticipate little action in the coming months. The Eurozone's annual inflation rate ended last year slightly below the central bank's 2% target, while economic growth for 2025 is proving stronger than previously expected.
This situation implies that European interest rates will likely remain low for the foreseeable future, yet it also intensifies the policy dilemma facing the central bank—balancing the need to address disinflationary pressures against the risk of an economic slowdown.
The depreciation of the US dollar has captured the attention of the ECB.
Although ECB policymakers believe the current situation is in a "good place," underlying concerns about the future persist.
A sustained weak dollar could further depress inflation by lowering the prices of imported goods and services and dampening demand for Eurozone exports. ECB officials have stated that a stronger euro, potentially triggered by more accommodative-than-expected US monetary policy and the associated dollar weakness, could amplify the effects of tariffs and push inflation lower than anticipated.
Last week, French Central Bank Governor Francois Villeroy de Galhau indicated that the ECB is "closely monitoring" the dollar's depreciation, noting it is "one of the factors that will guide our monetary policy stance."
ECB President Christine Lagarde may face questions on this topic during her post-decision press conference. Bas van Geffen of Rabobank suggested that Lagarde might attempt to slow the euro's appreciation slightly through verbal intervention, but added that the currency likely has room to strengthen further before another rate cut becomes necessary.
Market analysis indicates that the Federal Reserve's pause on rate hikes last week, ending an adjustment cycle that began last July, and its signal of no rush to resume easing have contributed to the dynamic.
A surge in cheap imports presents another factor that could exacerbate disinflationary pressures, a threat that received significant attention during the policymakers' December meeting.
According to the minutes from the ECB's December meeting, the central bank reiterated that inflation should stabilize at the 2% target in the medium term, but acknowledged that services inflation and wage growth have been more persistent than expected.
Policymakers observed that exporters from other countries were cutting prices "more quickly than in the past" to find new customers and replace markets lost due to US tariff increases.
ECB economists project that the inflation rate will be below the target this year, move closer to it by 2027, and only return to 2% in 2028.
Markets currently expect the ECB's key rate to be held at 2% this week, with the central bank emphasizing its openness to act in either direction should the inflation outlook change.
The Bank of England faces a similar conundrum.
Dollar weakness and the influx of cheap imports are likely to have a comparable impact on the UK.
BOE Monetary Policy Committee member Alan Taylor has highlighted the threat posed by the surge in imported goods. Unlike the ECB, a majority of BOE policymakers agree that rates should be cut again this year, but they are divided on the timing.
Analysis suggests a rate cut this week appears premature for most members, who require further confirmation that wage growth will slow sufficiently to ensure inflation stabilizes near the 2% target after its anticipated decline in April.
Edward Allenby of Oxford Economics noted that while a majority of the MPC expect further rate cuts will be needed, they are concerned about the potential strength of wage settlements in 2026 and the subsequent impact on inflation. He indicated that the meeting at the end of April is viewed as the most likely timing for the next cut.
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