ECB Report, Nord Stream 1 News Sparks Big Jump in Euro Exchange Rates

Image © European Central Bank.

The European Central Bank could raise the Deposit Rate by 50 basis point this Thursday while seperate reports suggest Nord Stream 1 will restart on Thursday as planned, two developments that sent Euro exchange rates sharply higher on Tuesday.

A 50bp hike at the ECB is larger than the market's currently anticipated 25bp and suggests the ECB is keen to make a rapid start on normalising interest rates.

"ECB Policymakers To Discuss Rate Hike Worth 25 Bps Or 50 Bps At Thursday's Meeting," read a Reuters newswire flash.

The Euro jumped on the news.

"A Reuters report this morning has suggested that the ECB officials will be discussing a 0.5% rate hike on a worsening inflation backdrop. Money market bets increased to a 40% chance of such a hike for this Thursday and the euro has strengthened off the back of the report. The importance of Thursday for the euro has intensified further," says Thanim Islam, Dealer Manager at Equals Money.

The Pound-Euro exchange rate gapped lower around the time of the release; a strong uptick was also recorded in the Euro-Dollar exchange rate:

Above: GBP/EUR (top) and EUR/USD (bottom) at 30 minute intervals.

The ECB is a key event for the Euro this coming week with markets not just looking at the scale of the incoming rate hike but also guidance on how many further hikes are likely.

ECB President Christine Lagarde and other policy makers have been clear they prefer a gradual approach to raising interest rates and this solidified expectations for a 25bp rise in July, although expectations for a more sizeable 50bp was widely expected by markets for September.

"The focus, however, will fall on ECB's communication around the future hiking path, with markets currently pricing in 60bp and 45bp hikes in September and October," says a weekly currency briefing from strategists at Barclays.

But there is more: the ECB is expected to detail a programme as to how it will keep the cost of borrowing lower in countries such as Italy and Greece at a time of rising interest rates.

This so called stability mechanism (anti-fragmentation tool) will be key in keeping the Eurozone together over coming years in an environment of rising interest rates and increased borrowing costs.

The Reuters report said ECB polciy makers were also approaching a deal to provide help for indebted countries like Italy on the bond market if they stick to European Commission rules on reforms and budget discipline.

Failure to adequately lay out a plan to do so this Thursday could yet prove the biggest challenge for the Euro.

Goldman Sachs anticipates the anti-fragmentation tool will be unlimited in size and subject to macro conditionality linked to existing EU frameworks, such as implementation of the Recovery Fund and adherence to fiscal rules.

"A limited size or more stringent conditionality would be important negatives for the Euro," says Zach Pandl, Co-head of FX Strategy at Goldman Sachs.

Good News on Gas

It was not just headlines regarding the ECB that were supporting Euro exchange rates on Tuesday owing to further headlines concerning the near-term outlook for Russian gas supplies to Germany.

The Nord Stream 1 pipeline is seen restarting on time on Thursday after the completion of scheduled maintenance, two sources familiar with the export plans told Reuters.

We reported foreign exchange analysts saw a delayed restart to gas supplies as being this week's key risk to the Euro.

The headlines suggest the odds of a negative shock to the Euro are therefore greatly reduced.

Earlier on Tuesday, the Wall Street Journal reported, citing European Budget Commissioner Johannes Hahn, that the European Commission did not expect the pipeline to restart after the maintenance.

Reuters reports the pipeline was expected to resume operation on time, but at less than its capacity of some 160 million cubic metres (mcm) per day.