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ECB February Meeting Reaction: Hawkish Lagarde sends euro higher

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3 February 2022

Written by
Matthew Ryan

Matthew Ryan is Ebury’s Global Head of Market Strategy, based in London, where he has been part of the strategy team since 2014. He provides fundamental FX analysis for a wide range of G10 and emerging market currencies.

The euro rallied against its major peers on Thursday afternoon, after a hawkish press conference from European Central Bank President Christine Lagarde opened the door to higher interest rates in the common bloc at some point in 2022.

N
o policy changes were expected from the ECB today, nor did we receive any. Investors were more interested in the bank’s view on domestic price pressures and any signs that policymakers were wavering in their view that interest rate hikes in 2022 were unlikely. On inflation, Lagarde noted in her presser that supply bottlenecks may persist for some time and that price pressures are set to remain elevated for longer than expected. While she continued to describe risks to the growth outlook as broadly balanced, she noted that risks to the inflation outlook were ‘tilted to the upside’. The view that inflation was to ‘decline in the course of [this] year’ was also removed from the inflation assessment.

We have been saying for a while that the European Central Bank was underestimating the persistence of the inflation overshoot, and today’s hawkish message goes a long way in acknowledging that. We have also been somewhat contrarian in our view that we would soon see a growing chorus of hawkish dissent among Governing Council members. All this was evident in Lagarde’s communications on Thursday, particularly in her comment that the recent inflation overshoot (Figure 1) had caused ‘unanimous concern’ among policymakers. She also noted that inflation might be ‘significantly higher’ than expected this year, although we won’t receive updated projections from the ECB until March.

Figure 1: Euro Area Inflation Rate (2013 – 2022)

Source: Refinitiv Datastream Date: 03/02/2022

Today’s meeting supports a view that we first voiced in early-December – that higher interest rates in the Eurozone cannot wait until 2023. Not only did the ECB signal heightened concerns over the inflation overshoot, but Lagarde also did not repeat her line that interest rate increases were unlikely in 2022 when directly asked – a critical change. This is a clear signal to markets that the Governing Council now appears unlikely to lag behind its major peers in hiking rates to the extent that had been previously anticipated. Investors reacted by raising bets in favour of ECB interest rate hikes in 2022. By the end of Lagarde’s press conference, swap markets were pricing in approximately 40 basis points of hikes in the ECB’s deposit rate by the end of this year, with the first 10 basis point move now fully priced in for the July meeting. In FX, the euro rose sharply following Lagarde’s hawkish remarks, rallying back above the 1.14 level versus the US dollar for the first time since mid-January, having begun London trading below 1.13.

Figure 2: EUR/USD (31/01/2022 – 03/02/2022)

Source: Refinitiv Date: 03/02/2022

The March meeting of the European Central Bank is now likely to be the most important since the first months of the pandemic. Lagarde stressed that the bank won’t begin raising interest rates until after it has ended its asset purchase programme, which is currently set to run until at least October. We do, however, expect net asset purchases to be wound down to zero much quicker than that, with an announcement now likely at next month’s meeting. Indeed, according to sources, the ECB views a recalibration of its bond purchases in March as possible. This would open the door to higher rates in H2 2022, we think most likely at the September meeting.

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