ECB sets course for interest rate hikes

The European Central Bank’s (ECB) June 9 monetary policy decision is likely to be a highly significant one, as the central bank is seen signaling its first-rate hike in over a decade. Increasing signs of inflation broadening out in the old continent have compelled the ECB to prepare for a lift-off sooner than previously expected.

The ECB is unanimously expected to hold its benchmark deposit rate at -0.50% when it meets this Thursday to decide on its monetary policy. Although the central bank could announce an end of its regular asset purchase program (APP) on July 1.

Despite being the laggards of the central banks to embark on the tightening cycle, ECB President Christine Lagarde has well telegraphed the upcoming rate hike track.

The ECB last increased borrowing costs in 2011, when higher prices pushed inflation beyond its “2% or close to 2%” target, and then-President Jean-Claude Trichet decided to act with “strong vigilance.” It was a total disaster. The eurozone entered a second recession and policymakers have since had to invent new tools to prevent deflation.

the main focus of the markets will be on whether there will be any indication of the pace of interest rate hikes. Most recently, some members of the ECB’s Governing Council had put rate hikes of 50bp into play. In contrast, however, ECB Chief Economist Lane and ECB President Lagarde stuck to the gradual approach that the ECB has been talking about for months and gave clear indications of rate hikes of 25bp each in July and September. 

High inflation and sharply rising interest rates pose downside risks to the economy that are hard to assess at present. In our view, this argues in favor of a cautious approach by the central bank. The Governing Council will not commit itself, but we expect further indications that the gradual approach is the most likely one. The market’s interest rate expectations should thus be dampened.

Anyway, the EUR/USD bulls are in charge and the pair is eyeing a test of recent highs near the 1.0800 level. A more hawkish than expected ECB (perhaps President Christine Lagarde openly endorses the idea of a 50 bps hike in the next few months) could be one catalyst to push the pair above 1.0800 and to fresh multi-week highs. Another catalyst could be if Friday’s US Consumer Price Inflation (CPI) data offers further evidence of easing US price pressures, which might encourage the market to pare back on Fed tightening bets.

A break above 1.0800 would open the door to a run higher to the next key area of resistance in the mid-1.0900s. Such a move would be consequential from a technical standpoint as many might interpret it as snapping EUR/USD out of the negative trend that it has more or less been locked within since May 2021.