Euro: ECB Hikes Big, says "Inflation Remains far too High"

Image © European Central Bank

Euro exchange rates found support in the wake of the European Central Bank's (ECB) 75 basis point interest rate hike and the clear message it will continue to hike as "inflation remains far too high".

The Euro recovered above parity against the Dollar and held near its strongest levels against the Pound since June after the ECB announced its largest ever interest rate rise.

However, the FX picture was somewhat muddied by the Chairman of the Federal Reserve, Jerome Powell, who proved rather rude in going against convention and scheduling a speech at exactly the same time as ECB President Christine Lagarde was addressing the press.

Powell sounded as 'hawish' as ever and the Dollar subsequently went higher, confirming the Fed and USD trump all else.

But make no mistake, this was as hawkish as the ECB can get. The rate hike was applied to all three basic interest rates and therefore takes the all-important Deposit Rate to 0.75%, thereby leaving behind an era of negative or flat rates.

"Inflation remains far too high," said the ECB in a statement, and it is "likely to stay above target for an extended period."

"This major step frontloads the transition from the prevailing highly accommodative level of policy rates towards levels that will ensure the timely return of inflation to the ECB’s 2% medium-term target," added the statement.

The ECB said the Governing Council - the body charged with setting policy - expects to raise interest rates further to dampen demand and guard against the risk of a persistent upward shift in inflation expectations.

They remain committed to the simpler policy of reacting to incoming data as opposed to detailing any forward guidance.

ECB economists have meanwhile significantly revised up their inflation projections, saying it is now expected to average 8.1% in 2022, 5.5% in 2023 and 2.3% in 2024.

However projections for economic growth "have been revised down markedly" for the remainder of the current year and throughout 2023.

The ECB did raise its 2022 GDP forecast to 3.1% from 2.8% previously, but the 2023 GDP forecast is slashed to 0.9% from 2.1 and the 2024 GDP forecast to 1.9% from 2.1% previously.

For investors the message is clear: the ECB is concerned only about inflation and will raise interest rates accordingly.

For the Euro this will prove supportive as currency markets tend to reward such clarity in purpose at a time of elevated inflation.

This stands in stark contrast to the muddled communication and reluctance to hike at the Bank of England, which consistently undermines the Pound.

The Euro to Dollar exchange rate rose to 1.0007 in the wake of the statement, taking rates for dollar payments on bank accounts to around 0.9727 and those at payment specialists to around 0.9977.

The Euro to Pound exchange rate rose to 0.8680, taking bank account quotes for pound payments to around 0.8437 and those at payment specialists to around 0.8654.

From a Pound to Euro perspective, the relevant levels are, spot: 1.1518, banks: 1.1288 and payment providers: 1.1483.

"As hawkish as you get from the ECB with a 75bps hike & pledge to keep raising rates in next several meetings. Many want to sell the EUR and may use argument that there was no direct reference to FX in the statement. Probably naive, hawks very worried about further EUR weakness," says Viraj Patel, a strategist at Vanda Research.