Forex traders are bracing for one of the European Central Bank‘s most crucial meetings in years, where policymakers are expected to pave the way for its first rate hike since 2011.
Options pricing suggests traders haven’t been so nervous about an ECB rate decision since 2019. With the bank expected to hold rates steady on Thursday, the question is whether the ECB’s chairwoman the ECB, Christine Lagarde, will push back expectations of 50-base-point increases in the future, which have been building up over the past few weeks as the record pace of inflation in the region continues to accelerate.
This decision could be a game-changer for the euro. The common currency has been mired by concerns over euro zone growth and the resurgence of the dollar as the Federal Reserve embarks on a rapid bullish cycle. A decidedly hawkish pivot could help convince bears that policymakers are determined to tighten financial conditions despite headwinds, lifting them even further from a five-year low against the dollar hit last month.
The extent of any movement in the euro – in either direction – “will depend on the degree of urgency that will be presented by Lagarde,” said Ulrich Leuchtmann, head of currency strategy at Commerzbank.
“Anything indicating steps of 50 basis points would be positive for the euro, as there are enough market participants who are still skeptical about the ECB’s willingness to rise quickly,” he said. he declares.
Morgan Stanley strategists including Wanting Low recommend targeting the euro-dollar pair at 1.10 following the decision, a level not seen since early April, as ECB policymakers ramp up their hawkish rhetoric. BMO Capital Markets strategist Stephen Gallo attributes a 20% chance to a “very hawkish” scenario that sees the ECB raise rates at Thursday’s meeting, which could drive the euro-dollar pair close or ” moderately above” this level.
Over the past few weeks, markets have started betting on around 140 basis points of rate hikes by the end of the year and are betting on a 50 basis point increase by September. Some members of the Governing Council have signaled their openness to larger moves amid concerns about the extent of inflationary pressures.
Comments on the possibility of a tool to contain the widening of the spreads between bond yields in the core and the periphery of the euro zone also reinforced the fact that the ECB could be able to control the risk of fragmentation and continue to increase.
This narrowed the yield spread between short-term US government bonds and their European counterparts, a key driver of the euro-dollar pair. By this metric alone, the Euro should be trading closer to $1.09.
Still, any disappointment could only mean further weakness for the euro. People have been rebuilding long positions in the common currency, according to Rabobank FX strategist Jane Foley, which are vulnerable if policymakers fend off market enthusiasm.
“Even if the ECB strongly signals the risk of a 25 basis point move next month, that would probably not produce any support for the euro,” she said. “I think a bit more downside potential may be in store for EUR/USD over the next few days.”