The European Central Bank (ECB) is expected to raise key rates by 25 basis points which could provide support for the euro.
EUR/USD strengthened on Wednesday and reached its highest in over a year and continued to rise early Thursday before coming under pressure ahead of the key event of the day. The ECB will announce its monetary policy decision later in the day and the pair could strengthen if the ECB appears hawkish and its monetary policy outlook diverges from that of the US Federal Reserve (Fed).
Federal Reserve monetary policy
On Wednesday, the Fed announced that it raised the policy rate by 25 basis points as anticipated. In the policy statement, the Fed avoided any language that mentioned further rate increases while in the post-meeting press conference, FOMC Chairman Jerome Powell avoided any reference to a pause in rate hikes in June and said that for this year there won’t be any rate cuts. Markets do not expect another rate hike in June.
ECB interest rate decision on Thursday
According to forecasts, the ECB is expected to increase its key rates by 25 basis points. In April, a number of ECB policymakers mentioned the possibility of a larger 50 basis points hike in May, but recent developments have led the markets to believe that a smaller rate increase is more likely. The ECB’s Bank Lending Survey, released earlier this week, highlighted the adverse effects of high rates on credit demand.
- 50 basis points rate hike
At present, a 50 basis points rate hike appears highly improbable, but if it were to occur, it would be a noteworthy and unexpectedly hawkish move, likely leading to an increase in the EUR/USD exchange rate.
- 25 basis points rate hike
Alternatively, if the ECB decides to implement a 25 basis points hike while affirming their commitment to future rate raises, it should contribute to the Euro outperforming the USD.
- No rate hike
Conversely, if the ECB chooses not to commit to another rate increase during the upcoming meeting, the Euro could face downward pressure, potentially resulting in a substantial correction for the EUR/USD pair.
Christine Lagarde conference
President of the European Central Bank Christine Lagarde will hold a press conference on Thursday, (4 May at 12:45 GMT) after the publication of the ECB monetary policy decision statement. The Q&A session by Christine Lagarde will be closely watched by market participants for any clues regarding the central bank’s next moves. The projected 25 basis point rate hike could be accompanied by hawkish comments from the ECB president, while an unexpected 50-bps raise could be coupled with dovish comments by Lagarde.
While a bigger rate hike could strengthen the euro, a 25 bps hike could have a mixed effect depending on Lagarde’s comments and what the ECB expects moving forward. Analysts have noted that a cautious hawkish forward guidance will offer support to the euro in the short term, but a more cautious approach could weaken the euro.
Moving forward, market participants will turn their focus on the US weekly Initial Jobless Claims and the first-quarter Unit Labour Costs data. A sharp decline in jobless claims and a solid wage inflation reading could support the dollar and limit any gains for the EUR/USD pair.
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