Editor's Note: The article was updated to include new analyst comments.
(Kitco News) - Although the European Central Bank is not expected to cut interest rates when they meet on Thursday, some analysts believe that it is only a matter of time before rates are lowered, dragging down the euro and gold prices.
Ole Hansen, head of commodity strategy at Saxo Bank, said there has been a major shift in expectations ahead of Thursday’s meeting. He pointed out that calls for a rate cut started after the release of much weaker-than-expected inflation data.
On Oct. 31, the European Union reported that inflation for October dropped to 0.7% year-over-year. It was the lowest inflation reading since November 2009. Many analysts have pointed out that this is well below the central bank’s inflation target of 2%.
Although expectations of a rate cut continue to build, Hansen said that he is not expecting the ECB to cut interest rates on Thursday. However, he added the central bank could end up trying to talk rates down instead.
“Obviously they will have to address the issue of falling inflation,” he said.
Hansen said the increased risk of falling inflation coupled with a weaker growth outlook means that the ECB will probably have to act soon than later, which will continue to hurt the euro and as a result gold prices.
On Tuesday the European Commission released a report saying that growth will remain week. The commission said they expect the euro zone economy to grow by 0.5% in the second half of this year and remain flat for the entire year. At the same time, growth is expected to be 1.4% in 2014.
Looking at the gold market, Hansen said although prices are relatively neutral, he does see signs of growing bearish sentiment and continued easing monetary policy in Europe would add to the negative outlook.
“Institutional investors, through (exchange-traded funds) are still net sellers. Holdings are still being reduced,” he said. “Until we see that change, the upside potential is limited.”
Sarah Hewin, European economist at Standard Chartered, agreed that interest rates will probably remain unchanged on Thursday; however, she added she will be paying attention to the press conference to see if ECB President Mario Draghi gives any indication of a rate cut in December.
“We will look out for any change in tone in Draghi’s statement, in particular, whether inflation risks are seen as being ‘to the downside,’ as this could be the signal that the ECB is prepared to act next month,” she said. “That said, there is strong resistance from Germany for lower rates, policy-makers still expect that inflation will be in the 1-2% range over the medium term and they could well point to some glimmers of hope in terms of better bank lending conditions and the economic upswing.”
At previous press conferences, according to some analysts, Draghi has taken a modestly dovish stance; he has reiterated that interest rates will remain low for “an extended period.” At the October, meeting Draghi also said that the central bank is ready to use “all available” tools to contain market rates.
Peter Buchannan, senior economist at CIBC World Markets, doesn’t see a lot of great prospects for gold on Thursday even if they hold off on the rate cut. He added the firm is not convinced there will be a rate cut this week but CIBC is expecting to see either a rate cut or changes to the central bank’s Long-Term Refinancing Operations.
“The [0.7%] has put a lot of pressure on them to shift away from their view that the economy can take care of itself,” he said. “One concern I guess is that while sentiment has improved, it hasn’t been full reflected in on-the-ground numbers and very subdued inflation. That would be a bit of a negative for gold.”
Jessica Fung, commodity strategist for BMO Capital Markets, said that a rate cut on Thursday doesn’t automatically translate into lower gold prices.
She pointed out that gold has been under pressure ever since the European inflation data was released last week in anticipation of a potential rate cut.
“Obviously if the rates are cut, the euro will probably trade a little weaker, which is negative for gold on a very fundamental level,” she said. “However I largely feel that gold has priced this in.”
While some analysts are expecting an eventual interest rate cut, Gerhard Schubert, head of commodities at EmirateNBD, said that he thinks the central bank might decide to wait for more data before making a move. He added that the drop in inflation will likely be addressed during the press conference following the decision.
On a side note, Schubert pointed out that the EU countries have the same inflation rate as Japan, which is starting to rise because of its massive stimulus program, “while the [euro zone] is in danger in drifting into deflationary territory.”
Schubert added that although there is the potential for gold to move in relation to currency markets, he is not expecting to see anything major ahead of Friday’s U.S. employment report for October.
“Make no mistake, the main game changer will be the release of the non-farm payrolls on Friday and that is good for a US $20 to US $30 move,” he said.
Read the latest news in gold and precious metals markets at Kitco News.
By Neils Christensen of Kitco News; nchristensen@kitco.com
