ECB encounters moment of truth on rate policy

Finally, the European Central Bank is making a move in response to rising inflation by widely eyed decision on the first rate hike in more than ten years, but will suffice to turn the tide on the EUR/USD pair as the Euro is poised to revisit levels back below parity again? Thursday’s ECB’s monetary policy meeting will take place as scheduled and its awaited decision will be announced with the press conference getting underway.

The ECB is encountering a handful of current issues. Inflation is the number one issue that the central bank must keep on top of in a endeavours to avoid earnings corrosion or a stagnant economy. There is a historic rise in inflationary pressures all over the continent.

The ECB is also encountering other factors including Russia-Europe energy flows, and post-Covid-19 price hikes have caused a rapid surge in inflation, there is also the consumer price index (CPI) differential between Western and Asian nations.

Unlike peer central banks, the ECB was too slow to act despite the telling economic crisis. Rocketing inflation rates have done little to move Christine Lagarde and her colleagues, with the bank’s indecision helping to drive the euro lower against most other currencies. Eventually; the ECB’s hesitance stands in stark contrast to their counterparts in the UK, Canada, Australia, and the United States.

Interest rates

The European Central Bank faces moment of truth on interest rates. Despite this growing difference in rates, markets are pricing in a mere 25 to 30 basis point (bp) hike to the current deposit facility rate which lies at -0.50%. Given the fact that markets are seeing other regions hike by up to 100 bp, the ECB certainly has the capacity to surprise if, and only if, policymakers wish to.

Markets are looking towards the September meeting to provide a ramp up in monetary tightening. So, markets are pricing in a 130-bp move over the course of the next three-meetings.

Another issue that remains to be resolved comes in relation to bond yields, with surging Italian yields providing a problem for Lagarde. With risks increasing, the fact that Italian yields are so extended does stifle their ability to respond to the current crisis.

The plan is to provide a new anti-fragmentation backstop, which should help protect the value of the euro and benefit Southern European economies. While observers are not expecting to see it implemented on Thursday, traders keep an eye out for any clarification on how the policy would take shape.

CPI Compared

That gap can be explained in a number of ways, but it is certainly notable that while Japan has struggled with inflation, Chinese energy pressures have been notably less problematic as they have taken much of the excess Russian output rejected by Europe which is still struggling to shift away from Russian energy just as other inflationary pressures build up.

Russian Oil Exports

Inflation expectations across both the US and Eurozone have eased somewhat over the course of June. While this does take some of the heat off the ECB, they still have to deal with the fact that headline CPI currently stands at 8.6%.

Inflation Expectations

Several European indicators, including retail sales, PMI surveys, GDP, and consumer confidence are all receiving a fierce blow over as the continent’s crisis plays out. There is clearly a need to address inflation, but the ECB will also want to be cautious to avoid a sharp recession where possible.