The European Central Bank is releasing its interest rate decision today (12:15 GMT) and markets anticipate the central bank to remain on hold. Market participants expect the bank to keep its monetary policy settings unchanged but they will closely watch the bank’s accompanying statement and the press conference with ECB President Christine Lagarde for signals regarding the bank’s plans. If the bank shows that is determined to keep rates high for an extended period of time while striking a hawkish tone, then the EUR will strengthen.
With inflation and growth dropping, the ECB is expected to remain on hold, but it may keep the door open for further hikes or a faster reduction of its balance sheet which could provide reassurance to ECB hawks. On the other hand, unconvincing ECB messages, an emphasis on the Eurozone’s recession risks, and America’s economic advantage, may disappoint and weaken the euro against the US dollar.
Inflation and economy are cooling down
While it’s good news that inflation is easing off, Eurozone economies cooling off is bad news. The European Central Bank (ECB) is expected to leave interest rates unchanged after delivering 10 consecutive hikes, but there is a possibility of leaving room for more.
The ECB’s main goal is to keep headline inflation at around 2% and with inflation continuing to fall, the ECB’s 2% target appears to be within reach in a few months.
After increasing borrowing costs by 25 bps in its last four meetings, ECB policymakers may take a breather as inflation is lower and economic prospects are looking gloomy. The ECB has also lowered its recent growth forecasts. So, leaving rates the same is something priced in by markets and investors will mostly respond to the ECB’s next moves.
Will the ECB express a hawkish stance?
Leaving rates unchanged doesn’t necessarily mean that the ECB’s work is done or that rate cuts are coming soon. Some analysts have argued that the ECB President Christine Lagarde and her colleagues will possibly support the opposite and prefer to remain alert as they monitor economic conditions. Core inflation is still high, energy prices may rise, while checking further economic data is key. With underlying price pressures remaining high, the bank may choose to act to encourage savings and inhibit lending. The Core Consumer Price Index (Core CPI) may have dropped to 4.5% but the next drop may be more difficult to deliver. Additionally, services sector costs remain elevated and may not fall any time soon.
Another reason for remaining hawkish is the fact that the ECB may prefer to rely on data and wait for the next meeting before signalling that the hiking cycle has ended.
Finally, higher energy prices may pose further risks. If the ECB indicates that rate hikes are over, it could weaken the euro. With the ongoing conflict in the Middle East and potential risks to Oil supplies, Oil prices may rise sharply. With Europe importing most of its energy, which is also denominated in US dollars, any signal from the ECB that could weaken the euro would be cautiously avoided.
How will the euro react?
While a rate hold is expected and priced in, the euro will strengthen if the ECB remains hawkish. Analysts have noted that whatever support the euro may receive from today’s meeting, may be short lived due to looming recession concerns. When it comes to the EUR/USD, the USD may remain strong due to a stronger economy, while the US release of the Gross Domestic Product (GDP) later today (12:30 GMT) could help support the dollar, as annualised growth rate is forecast to come in at more than 4%.