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ECB October Meeting Reaction: Lagarde dismisses market’s rate hike view

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29 October 2021

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 ECB tried to push back against expectations for higher European rates following Thursday’s Governing Council meeting with very mixed success, as the euro still rallied sharply and expectations for hikes in the Eurozone were actually brought forward in markets.

T
he bank’s statement was little changed from the September meeting. As expected, the ECB held off from announcing how it plans to wind down its emergency bond buying programme (PEPP), with a decision set to be made in December. President Lagarde’s press conference was a little bit of a mixed bag. We think that she again sounded dovish on inflation, continuing to reaffirm the bank’s view that price pressures would ease over the course of next year. The bank also still sees inflation below its 2% target over the medium-term. Lagarde did, at least, acknowledge that this decline in inflation would take longer than previously anticipated, due in large part to the persistence of supply bottlenecks. This is a slightly more hawkish assessment than we received in September.

The ECB does, however, remain very dovish on interest rates. As we thought that she might, Lagarde pushed back against market expectations for rate increases. Prior to the meeting, futures markets were pricing in around 10 basis points worth of hikes in the ECB’s deposit rate by the end of next year, and 40 basis points by the end of 2023. According to Lagarde, under the bank’s current analysis, the conditions for a lift off in rates are ‘not satisfied’, nor will they be in the near future. This is a very dovish signal, particularly at a time when most other G10 and emerging market central banks are delivering hawkish surprises.

The euro reacted in a rather unusual manner to the presser, appreciating against every other major currency. EUR/USD has rallied by over half a percent this afternoon, although we note that the dollar has sold-off across the board following today’s US GDP miss. It appears that the market was bracing for an even more dovish message than we had anticipated, and investors were perhaps expecting a more forceful pushback against market pricing than Lagarde delivered. Moreover, in a rather uncharacteristic fashion, Lagarde preemptively voiced her view that the PEPP programme would likely end as planned in March. Some factions of the market had expected a short extension in the bond buying programme, to be announced in December, although that now appears unlikely. This commitment (of sorts) to tighten policy, combined with the market’s already ultra-dovish expectations, may partly explain the move higher in yields and the common currency (Figure 1).

Figure 1: EUR/USD vs. German 2Y Government Bond Yield (MTD)

Source: Refinitiv Datastream Date: 28/10/2021

Despite the immediate reaction in the euro, we are becoming increasingly less bullish on EUR/USD, and will likely be revising our long-term forecasts lower. The ECB now appears on course to considerably lag most of its G10 peers in raising interest rates during the upcoming hike cycle, and that does not present a particularly conducive environment for common currency strength.

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