GBP/EUR ECB Reaction: Higher after 'Mini' 25bp Hike

Above: File image of ECB President Lagarde. Image copyright European Central Bank.

The Euro fell against Pound Sterling, the Dollar and other majors after the European Central Bank (ECB) opted to raise interest rates 25 basis points.

The market was split as to whether the central bank would opt for 25bp or a bigger 50bp move and we reported the former would result in knee-jerk Euro weakness.

In line with this expectation, the Pound to Euro exchange rate (GBP/EUR) spiked in the minutes following the decision to 1.14, having been at 1.1354 just minutes prior.

The Euro to Dollar rate had been as high as 1.1090 in the run-up but was back at 1.1025 in the aftermath.

Above: GBP/EUR rallies in response to the ECB decision.

The ECB's main refinancing rate is now at 3.75% and the deposit rate at 3.25%, meaning Eurozone base rates are at their highest in almost a decade.

The rise in rates has attracted foreign investor capital and encouraged the repatriation of Eurozone-resident investor funds as domestic asset returns improve.

This has been a fundamental driver of Euro exchange rate appreciation since late 2022.

Key to the Euro's future performance will be how many further hikes the ECB can deliver and the statement issued by the Governing Council confirms future rate decisions will be based on the regional inflation outlook.

But the Euro's downside could be limited as the ECB announced something of a 'hawkish' surprise by announcing it will increase the pace it reduces its holding of bonds acquired during the period of quantitative easing.

The current run-rate sees the ECB reduce its bond holdings by €EUR 15BN per month, which will continue through May and June.

But from July the pace doubles to €EUR 30BN per month as the ECB ends altogether its policy of reinvestmenting in bonds that reach maturity.

Heading into the ECB decision market positioning data showed investors held their biggest 'long' position on the Euro since late 2020.

This left the Euro at risk of a setback if the ECB disappointed with a softer-than-expected decision. In fact, the bar is now set quite high for the ECB to push its hawkish credentials even further,  something that would be required to sustain ongoing Euro strength.

"The European Central Bank has hiked its policy interest rate by 25bp and seems to have entered the final stage of its current tightening cycle," says Carsten Brzeski, Global Head of Macro at ING Bank.

"In the current, very complicated macro environment with the lagged impact from previous hikes, banking turmoil, and subdued growth but still sticky inflation, the ECB will tread more carefully," he adds.

It looks like the peak is in for ECB rate hike expectations, raising the prospect that the near-term peak for Euro exchange rates has also been reached.