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ECB to Raise Rates, but Maybe Not As Much as Expected

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Over the last several weeks, many ECB members have been making the case that rates need to go up. Not just that there needs to be at least a “double” hike at the coming meeting, but further hikes after that. Only Centeno intimated that the interest rate was getting near a level when hiking would need to be reconsidered.

NFP Feb 3 2023

The thing is, from the minutes of the last meeting, it appears that ECB members talk tough, but in the end vote for less of a hike. Many members called for 75bps at the last meeting, but ultimately the vote was for 50bps. And there are many reasons for the shared central bank to be nervous about hiking in the current environment, particularly after the latest data.

What the forecasts say

For now, the consensus is that the ECB will hike by 50bps, and will signal that further rate hikes will be needed in the future. That is in line with the accepted central bank theory that inflation is driven by expectations. Which means that the ECB believes it needs to convey a harsh stance to get inflation down, even if they expect to start slowing the pace of hikes in the near future.

The issue for the EURUSD, of course, is where the interest rates of both economies will end up at. Both central banks are insisting that they will raise as much as it takes to get inflation under control. But the ECB is much further behind the Fed, and that gap is what caused the Euro to fall below parity. Now that the Fed is slowing the pace and the ECB is still hiking aggressively, that gap has been narrowing, and pushing up the Euro pairs. But, if there are reasons for the ECB to slow the pace of hikes, then those gains could fade.

The data is pushing in different directions

The latest figures released this week point to the conflicting task that the ECB has to deal with. Preliminary Spanish inflation figures for January showed an increase in the annual rate, but a decrease in the monthly rate. Of more concern was that core inflation was much higher than anticipated, with inflation growing for the first time in a year.

That might mean more action from the ECB is necessary. But also yesterday Germany reported its first look at GDP figures for the last quarter, and they came in below expectations and into negative. That means the largest economy in Europe could be heading into a technical recession. After struggling for years with not enough inflation and anemic growth, now the ECB doesn’t want to push the economy back into that condition.

It’s more about the future

The expectation is that in the near term the ECB can get away with more tightening, at least until March. But, given the energy situation in winter, it might take a more cautious approach, hiking at a somewhat slower rate. Which could keep the Euro from posting a breakout through the winter, as there are multiple uncertainty points, especially with the war in Ukraine and talk of a spring offensive.

That could mean that in the end, the EURUSD could depend more on how the Fed slows down hikes more than how much the ECB keeps hiking.

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