Pound / Euro: Russian Invasion Could Prompt ECB to Delay Rate Hikes

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Euro exchange rates look vulnerable to calls for the European Central Bank to abandon 2023 rate hikes in the wake of the Russian invasion of Ukraine.

Greek central bank Governor Yannis Stournaras has called for the European Central Bank (ECB) to continue quantitative easing as the situation escalates.

"I would rather favour a continuation of the APP at least until the end of the year, beyond September, rather than bringing the end closer," says Stournaras.

Ending quantitative easing is considered a necessary first step ahead of rate hikes.

Therefore if the ECB continues with quantitative easing until year-end the prospect of a 2022 rate hike would be nil, providing an obvious downside narrative for the Euro.

Further such interventions from 'dovish' members of the ECB Governing Council are likely over coming days.

Investor expectations on how central banks will react to the Russian invasion of Ukraine will matter greatly for currencies over coming days.

"We have seen a bullish flattening of yield curves consistent with investors pricing lower growth. A key question will be whether investors price lower terminal rates for tightening cycles or whether the energy price shock firms up stagflationary fears and rates at the short end of the yield curve hold up well," says Chris Turner, Global Head of Markets at ING Bank.

Data shows investors have over recent hours lowered expectations for 2022-2023 rate hikes for the major central banks.

• Reference rates at publication:
  GBP to EUR: 1.2008
• High street bank rates (indicative): 1.1688 - 1.1772
• Payment specialist rates (indicative): 1.1900- 1.1948
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Yet the OIS market - a key gauge of these expectations - suggests investors are still positioned for up to 40 basis points of rate hikes from the ECB in 2022.

This could probably continue to diminish, with downside implications for the Euro.

The Euro to Dollar rate is down half a percent at 1.1250, the Euro to Pound rate is virtually unchanged at 0.8343 (Pound to Euro at 1.1985).

However what matters here is how fast rate hike expectations fall for other central banks.

There are 135 basis points of Bank of England rate hikes priced into GBP markets for the remainder of 2022 as of today, suggesting ample space for a retracement.

Indeed, yesterday the OIS market saw a 2.0% Bank Rate by March 16 2023, as of Thursday it is at 1.95%.

The Pound would be at risk were markets to price out Bank of England rate hikes faster than those of other central banks.

For now though it appears a uniform repricing lower is underway.

It is also hard to see just how low markets can push rate hike expectations given the war in Ukraine and looming sanctions are certainly inflationary in nature.

Surging oil and gas prices in response to the Russian invasion leaves central banks with little scope to push back against expectations for rate hikes.

It is perhaps because of this that most G10 currencies are proving relatively stable.