ECB Goes Uber-Hawkish, Boosting the Euro

Above: ECB president Christine Lagarde addresses the audience during the ECB Governing Council Press Conference on 27 October 2022, Frankfurt, Germany. Photo: Dirk Claus/ECB.

The Pound to Euro exchange rate (GBP/EUR) is sharply lower after the European Central Bank raised interest rates by a further 50 basis points but warned significantly more hikes are required than had previously been assumed.

Euro exchange rates were higher after the ECB said that based on the substantial upward revision to its inflation outlook it expects to raise interest rates further in the future.

"The Governing Council judges that interest rates will still have to rise significantly at a steady pace to reach levels that are sufficiently restrictive to ensure a timely return of inflation to the 2% medium-term target," said the ECB in a statement.

"That's a very hawkish 'pivot' from the ECB. Grim new forecasts and rate guidance. I think we need to contemplate rate hikes in Q2 too," says Claus Vistesen, an economist at Pantheon Macroeconomics.

ECB President Lagarde hammered home the 'hawkish' tilt by saying it was "obvious" that we should expect 50BP rate hikes for a period of time.

Vitor Constâncio, Former ECB Vice President, says the ECB's new tune is "bad news for Euro Area prospects. The ECB decisions, language and forecasts, point to an excessively hawkish policy that will aggravate the coming recession unnecessarily."

"The expression 'rates will still have to rise significantly' is grounded on controversial inflation forecasts," he says.

The Euro might end up baulking at the prospect of the ECB exacerbating the Eurozone's recession, but for now, the central bank's aggressive stance is playing supportive of Eurozone bond yields and the single currency.

The GBP/EUR rate was already under pressure in the wake of the Bank of England's decision, just over an hour prior, but losses accelerated following the ECB:

Above: GBP/EUR at 15-minute intervals. Consider setting a free FX rate alert here to better time your payment requirements.

At the time of writing GBP/EUR spot is at 1.1512, typical high-street banks are delivering euro payment rates at around 1.1282 but competitive payment providers are quoting nearer 1.1477. Competitive cash and holiday money providers are offering in the region of 1.1391.

The Euro has meanwhile extended its fourth-quarter advance against the Dollar as EUR/USD rose to its highest level since June at 1.0708.

The ECB also said it would start to reduce the size of the bond portfolio it built up under quantitative easing, a process known as quantitative tightening, from March 2023.

New projections from the ECB showed it upgraded its expectations for inflation to reach 3.4% in 2024 and 2.3% in 2025.

The ECB also expects a relatively benign recession as growth forecasts are set at 0.5% in 2023 and 1.9% in 2024.

"This is much more optimistic than our own growth forecast," says Carsten Brzeski, Global Head of Macro at ING Bank.

"Needless to say that with the still relatively optimistic growth outlook, the risk increases that the ECB pushes the eurozone economy further into recession with every new rate hike," he adds.

Robin Brooks, Chief Economist at the IIF, says Eurozone financial conditions are as tight as during peak-COVID in 2020 or the 2011/12 debt crisis, even as U.S. conditions ease.

"This can't be the objective of the ECB. Putin is waging an energy war that is pushing up inflation. Let's not keep hiking into that," says Brooks.

For now, the market's stance is that higher Eurozone interest rates are supportive of the currency and the Euro is flying as a result.

But currency weakness in the future cannot be ruled out if it soon becomes clear that the ECB is actively deepening the coming recession.

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