ECB meeting preview: finally lift off is in view
This Thursday the ECB is scheduled to have its latest policy meeting. Although no change is expected at this meeting, it will be by far one of the most important meetings in the ECB’s history. This is when the bank is expected to announce that it will formally end its net asset purchases and confirm that it will raise interest rates next month. We don’t think that there will be specific guidance about the size of the ECB’s rate hike, although it is worth noting that some ECB members have pushed for a 50bp rate hike after record high inflation.
The ECB joins the rate hike gang
The ECB has a tricky path to follow, it is unlikely to spook markets by sounding too hawkish, after all, the currency bloc continues to monitor closely the impact of the war on Ukraine. The ECB also must set rates while being mindful of the varied economies that it sets policy for. For example, there was enormous divergence in the April inflation rates: Estonia recorded a rate above 20%, while Malta saw inflation grow by just over 5%. However, even at the lower end of the scale, inflation is still way out of the ECB’s comfort zone, which is why the ECB is set to join the BOE and the Federal Reserve and hike interest rates, along with the RBA in Australia and the central bank of India, who are also expected to raise interest rates later this week.
50bp or 25bp, that is the question…
With inflation at 8.1% in the currency bloc, the ECB’s inflation forecasts have proven to be widely inaccurate, and there is a clear consensus for the ECB to crack on with hiking rates. The key argument is whether the ECB has the luxury of only raising rates by 25bps at the next few meetings, or whether it will have to move more quickly. The Austrian, Dutch, Latvian and Slovakian central bank governors have all called for a 50 bp rate hike next month, or at least for such a move to be considered. This is a sizeable faction. Thus, the comments from the ECB statement and Christine Lagarde’s press conference will be closely watched to see if the hawks have gained control at the ECB. We expect that the ECB President will be asked about the prospect of a 50bp rate hike at the press conference. Thus, the chance of a large reaction to this rate hike is growing and could have a big impact on the euro and key euro crosses.
The view from the FX market
One of the main drivers of the FX market is central bank divergences and relative sovereign bond yields. With the ECB playing catch up with the rest of the western world’s central banks and the prospect of a 50 bp rate hike from the ECB next month, then EUR/USD and EUR/GBP should be on your watch list.
EUR/USD:
This pair could be in focus at the end of the week as we wait for the ECB meeting on Thursday and the US CPI report on Friday. EUR/USD’s range in the lead up to this meeting is 1.0635 - 1.0800 and it is currently trading in the middle of this range. If the ECB chooses to play down volatility and refuse to engage in talk about a 50bp rate hike, then we could see EUR/USD move towards the bottom of this range, especially if we see US inflation fail to moderate as expected. A hawkish ECB, who puts the prospect of a 50bp rate hike on the table, could see a break of 1.0800.
EUR/GBP:
This pair is set to continue to rise in our view, at least throughout the summer. The diverging central bank stances – where the BOE is backing away from rate hikes after starting at the end of last year, while the ECB is gearing up to start hiking rates, makes us bearish towards the pound vs the euro in the coming months. This pair is also approaching a key resistance level around 0.8600, it is currently trading a notch below 0.8570. If it can break the 0.8600 level then it opens the door to a move back towards 0.8650, and then to 0.8710, the April 2021 high. Overall, if the ECB can show the markets that it is serious about tackling inflation in the currency bloc, then we could see the next leg higher in the euro vs. the GBP.