Euro exchange rates appear to be better shielded from further declines as inflation in the eurozone reduces the likelihood of significant rate cuts by the European Central Bank (ECB).

Inflation in the eurozone increased to 2.4% in December, up from 2.2%, while core inflation stayed steady at 2.7% for the fourth month in a row. These factors have lowered the chances of a rapid series of rate cuts by the ECB.

“The battered Euro's downside is finally looking better protected. We feel a lot of negatives have been priced in by now. The bar for euro area money markets to price in more ECB easing (100 bps this year) is rising,” said a KBC Bank note.

Strengthening market expectations are evident in the currency, as the Euro to Pound Sterling exchange rate holds steady around 0.8290, while the Euro to Dollar rate remains supported above the 1.0260 support level, Pound Sterling Live reports.

The ECB is forecast to ease during meetings in Q1, according to Head of Market Analysis at Lloyds Bank, Sam Hill: “It does mean that policy rates will remain restrictive for longer,” he said.

If eurozone inflation had fallen short of expectations and increased the likelihood of faster rate cuts, the Euro would have faced downward pressure. However, the current situation positions the Euro to be more resilient against weakness, especially against Sterling. 

The risks of a faster pace of rate cuts by the Bank of England could rise if the economy continues to slow.

“The BoE’s hawkish cut in November was followed by a dovish hold in December where one of the status quo voters is close in switching sides. We think current market pricing of only two rate cuts in 2025 is too conservative. That’s making both UK yields at the front end and sterling vulnerable for downside eco data misses. EUR/GBP’s bottom around 0.823 looks a bit better protected,” KBC added.

Downside risks for the Euro include the possibility of eurozone inflation declining more quickly than anticipated in Q1, which could occur due to favourable base effects.

“Our forecast is that the underlying inflation rate will slow at the start of the year, when the strong start in 2024 falls out of the comparative figures, so even if today's numbers matter to the ECB, their latest forecast will only be put to the test when we get the January and February numbers,” according to Marcus Widén, SEB analyst.

Furthermore, analysts at Capital Economics note that the elevated level of services inflation, which is driving core inflation, is partly attributed to temporary factors that are expected to subside this year.

“Meanwhile, the labour market has loosened, wage growth is slowing and the growth outlook is weak,” stated Jack Allen-Reynolds, deputy chief eurozone economist at Capital Economics.