Currency strategists broadly agree the ECB’s tone this week matters more for the euro than the widely expected hold itself, with the degree of hawkishness on further hikes seen as the key swing factor against the dollar. A clear signal that the Bank remains willing to act beyond September is viewed as the main defence against renewed euro weakness if the Middle East conflict escalates further and pushes energy prices higher. Rate markets have already moved to price in close to two additional hikes by year end, lifting short term euro area yields back near their highs for the year. Softer US inflation data has meanwhile tempered Fed rate hike expectations, helping yield spreads move in the euro’s favour and explaining why the dollar has not strengthened further despite rising energy costs.
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Earlier:
- Preview – ECB seen holding at 2.25% as Middle East conflict clouds outlook, September hike still in play
- Preview – Deutsche Bank sees ECB pausing this week before a September rate rise
FX strategists say the euro’s ability to withstand a further escalation in the Middle East conflict depends less on Thursday’s expected ECB hold than on how strongly policymakers signal they are prepared to keep raising rates beyond September.
Summary:
- One currency strategist (Commerzbank) said the euro should benefit if the ECB strongly signals willingness to raise rates further given escalating Middle East tensions and higher energy prices
- The ECB is expected to leave rates unchanged this week but hike again in September, according to the same note
- The strategist said how clearly the ECB signals readiness to raise rates beyond September will be decisive in limiting euro downside against the dollar if the US Iran conflict escalates further
- Separate analysis (MUFG) noted a back to back hike this week looks highly unlikely, with even hawkish Bundesbank President Joachim Nagel indicating he favours a hold
- That analysis said a sustained rebound in energy prices supports a forecast for a further 25 basis point hike in September
- Euro area rate markets are almost fully pricing in two further ECB hikes by year end, lifting short term rates back within reach of their year to date highs
- Softer US inflation data has dampened the impact of higher energy prices on Fed rate hike expectations, moving yield spreads in the euro’s favour
The European Central Bank’s tone on future rate hikes is likely to matter more for the euro this week than the widely expected decision to hold rates steady, according to currency strategists positioning ahead of Thursday’s meeting. With the ECB expected to leave rates unchanged before hiking again in September, one strategist said the euro should benefit if the central bank strongly signals it is willing to raise rates further as the escalating Middle East conflict pushes energy prices higher.
Given the recent rise in energy costs, that strategist said it is crucial how clearly the ECB underscores its readiness to raise rates beyond September, arguing this is likely to be decisive in limiting the euro’s downside against the dollar if the US Iran conflict escalates further.
A separate note took a similar view on the near term decision, noting that another back to back hike as soon as this week appears highly unlikely, pointing out that even hawkish officials such as Bundesbank President Joachim Nagel have indicated a preference for holding rates steady. That analysis nonetheless said the ECB is likely to signal it is considering further hikes after the summer, with a sustained rebound in energy prices supporting a forecast for another 25 basis point move in September.
Euro area rate markets have moved further still, almost fully pricing in two additional ECB hikes by year end and lifting short term rates back within touching distance of their highs for the year. At the same time, softer than expected US inflation data has initially dampened the impact of higher energy prices on Fed rate hike expectations, contributing to yield spreads shifting in favour of a stronger euro and weaker dollar heading into this week’s meeting. That dynamic helps explain why the dollar has not strengthened further despite the recent run up in energy prices.
Taken together, the two notes point to a market increasingly focused on the ECB’s forward guidance rather than the decision itself, with the balance between the Middle East conflict’s trajectory and the Federal Reserve’s own policy path likely to shape how the euro trades in the weeks ahead. The Governing Council’s decision is due at 14:15 CEST on Thursday, or 12:15 GMT and 8:15am US Eastern time, with President Christine Lagarde’s press conference to follow at 14:45 CEST, equivalent to 12:45 GMT and 8:45am US Eastern time.
This article was written by Eamonn Sheridan at investinglive.com.
