Euro Sold As ECB Signals the End is Nigh for Rate Hikes

File image of ECB President Christine Lagarde. Photo by Sanziana Perju / European Central Bank.

The European Central Bank (ECB) raised its three main interest rates by a further 25 basis points, as expected, but gave no clear indication it would hike interest rates again.

The Euro fell against most of its peers as investors lean towards a belief the central bank has ended its rate hiking cycle aimed at bringing inflation down to its 2.0% target.

In a statement, the ECB said inflation will drop further over the remainder of the year, but will stay above target for an extended period.

"The Governing Council’s future decisions will ensure that the key ECB interest rates will be set at sufficiently restrictive levels for as long as necessary," read the statement.

One key point to note in the above: previously this element of the statement read, "interest rates will be brought to sufficiently restrictive levels". 

This subtle, yet important, change steers the ECB's communication towards a hint that it has arrived at the peak and is now ready to pause the rate hiking cycle.

"The question is whether this is it for the hiking cycle. In a very slight but important tweak to the wording of the statement, the ECB has opened the door to a pause in September," says Mark Wall, Chief European Economist at Deutsche Bank.

In the post-decision press conference, ECB President Christine Lagarde confirmed the switch from "brought at" to "set at" was intentional.

"Dovish hike confirmed. And if we're all looking at the same data, and forward-looking expectations, a September hike looks very unlikely," says Viraj Patel, FX Strategist at Vanda Research.

In previous press conferences, Lagarde had also latched onto questions regarding future policy direction to pre-announce further hikes.

But this time, when asked if the ECB has more ground to cover, Lagarde said "at this point in time I wouldn't say so".

The ECB reckons past rate increases continue to be transmitted "forcefully" and have tightened financing conditions, which is acting to dampen demand.

The guidance also confirms a data-dependent approach is maintained with regard to deciding whether to raise interest rates again.

"The market is positioned long of the EUR, meaning that a lack of hawkishness in the ECB’s commentary today could leave the EUR on the back foot," says Jane Foley, Senior FX Strategist at Rabobank.

The Pound to Euro exchange rate rose as high as 1.1690 in the wake of the decision but eventually closed the day lower at 1.1655, in a move that would have disappointed Sterling bulls.

The Euro to Dollar exchange rate retreated back to 1.1080, having been as high as 1.1150 in the hours prior.

"On the assumption that ECB rates are close to peaking, we see EUR/USD trading down to the EUR/USD1.08 area on a 3-month view. We see the risks for EUR/GBP as being well balanced," says Foley.

Nevertheless, interpretations of the tone of the guidance will differ amongst analysts and market participants.

The reading at ING Bank is that this was in fact quite a 'hawkish' statement and the door to further interest rate hikes was "wide open".

This highlights that the prospect of a sustained depreciation in the Euro following the July decision is unlikely.

Instead, it places emphasis on the upcoming data releases, meaning currency market reactions to Eurozone inflation figures out in August will be elevated relative to past instances.