ECB goes big again despite pending slowdown
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27 October 2022
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.
As expected, the European Central Bank raised all three of its main interest rates by 75 basis points on Thursday for the second time in as many meetings.
There were no big surprises in the bank’s statement, though the tweaks that were made from the September meeting were perceived as dovish by market participants, correctly in our view. The Governing Council said that it would continue to set interest rates on a meeting-by-meeting basis, rather than providing any explicit forward guidance. The statement also noted that the bank expects to continue raising interest rates in order to meet its 2% medium-term inflation target. It did, however, drop the language ‘over the next several’ meetings, in favour of expecting to raise rates ‘further’.
As we anticipated in our ECB preview report, there was no announcement on a timetable on QT. In our view, this would have been premature given the uncertainties facing global financial markets and the European economy. The ECB announced some changes to its targeted long-term refinancing operations (TLTROs), saying that the interest rate on these loans will be indexed to the average applicable key interest rate – a largely inconsequential development for currency markets. It will also continue to reinvest APP proceeds in full for an extended period of time beyond the date when it started raising rates.
At the press conference, Lagarde said that the Euro Area economy is likely to have slowed significantly in the third quarter, and that it was expected to decelerate substantially during the remainder of the year. She did, however, once again warn that risks to inflation remain on the upside, while noting that price pressure had broadened and that inflation had been exacerbated by the depreciation of the euro. Despite the clear downside risks to growth, we think that bringing down consumer prices in the bloc will remain the top priority at the ECB. Lagarde said during her presser that rates may need to be raised at ‘several’ meetings, and that the bank may need to go beyond normalisation.
All in all, we think that today’s announcement went largely according to the script, and it doesn’t materially change our outlook on either interest rates or the euro. We continue to believe that the Governing Council will need to raise rates deeper into 2023 than the Federal Reserve, particularly as we are yet to see signs of a peak in either the headline or core rates of Euro Area inflation. The common currency briefly sold-off back below the parity level on the US dollar following the statement, although it has recovered most of its losses at the time of writing. We think that this largely reflects the tweak in the wording on interest rates, which we believe merely gives the ECB flexibility to raise rates on a meeting-by-meeting basis, rather than pre-committing to multiple hikes in one go.
Figure 1: EUR/USD (27/10/2022)
Source: Refinitiv Date: 27/10/2022
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