ECB Decision: Analyst Views on What it Means for Europe and the Euro Outlook

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Euro exchange rates were highly volatile and eventually fell broadly in the wake of the June European Central Bank (ECB) monetary policy decision, which drew mixed reactions from economists and elicited mostly bearish commentary about the single currency from the analyst community. 

The ECB warned on Thursday that European inflation pressures are beginning to seep into prices charged across the economy after having broadened out from their roots in commodity and tradable goods markets as it announced steep upgrades to its forecasts for price growth.

It now sees inflation remaining above the 2% target at the other end of its forecast horizon and June projection for core inflation at that time was higher than that for the main inflation rate, which is ultimately what led to Thursday’s landmark shift in the bank’s policy stance. 

This led the ECB to effectively pre-announce a 0.25% July increase in all three of its interest rates and to provide guidance that creates room for the bank to proceed in increments of 0.50% or more from as soon as September if the intervening inflation developments make it necessary.

Above: Euro to Dollar rate shown at daily intervals alongside spread - or gap - between 02-year German and U.S. government bond yields (black line) and S&P 500. Click image for closer inspection.

The decision pushed market-implied measures of expectations to quickly suggest investors are now anticipating almost 140 basis points of increases in total for the ECB’s interest rates before year-end, which would lift its deposit rate from a subzero -0.50% to 0.89% 

But analyst readings of the policy decision and views on what it could mean for the single currency have been broadly downbeat, if not outright bearish, and Euro exchange rates did fall widely in the hours after the announcement.

Part of that price action may have reflected other factors such as the risk of fresh coronavirus-related shutdowns in Shanghai, which appeared to help drive widespread losses for stock markets across the world, although many cite ECB policy and other factors for their bearish views on the Euro.

Some of these views are set out in part below. 

Valentin Marinov, head of G10 FX strategy, Credit Agricole CIB

"The bank’s updated inflation projections further showed a considerable upward revision further suggesting a more aggressive tightening cycle than priced by the markets ahead of the meeting."

"The apparent shift in the ECB’s policy priorities towards monetary tightening and away from maintaining favourable financial conditions weighed on EUR-denominated risk assets and could continue to add to market concerns about the Eurozone growth outlook in particular."

"The EUR itself seems caught between the conflicting impact of growing Eurozone rates on the one hand and wider peripheral spreads on the other. We expect that this will continue for now given that, historically, the EUR-USD rate spread and the peripheral spreads to Bund yields were the two most important EUR/USD drivers according to our FAST FX fair value model."

"This also underpins our neutral near-term outlook on EUR/USD from current levels. Further out, we think that for the EUR to re-couple with growing Eurozone rates, the ECB will have to convince the market that it can tighten policy without significantly aggravating the sell-off in the Eurozone periphery."

Dominic Bunning, European head of FX research, HSBC

“The ECB’s decision and press conference today offered relatively little new information for the EUR and may see downside pressure resume for the currency after its recent rally.”

“Recent EUR strength has been largely a function of a rising rate differential versus the USD, with the 2y yield spread narrowing 50bp since the middle of May for example. This has been accompanied by a significant reduction in speculative short EUR positions.”

“Absent a more hawkish outlook from the ECB – or a more dovish shift from the Fed – it will be hard for this gap to narrow further, limiting the room for EUR gains. Indeed, the FX market might start to focus on a deteriorating growth outlook for the Eurozone, which could limit the degree to which the ECB can deliver the amount of tightening priced by the market through the rest of 2022.”

Jordan Rochester, FX strategist, Nomura 

“Expecting EUR to head higher from here suggests a view that October will be a 100% probability of a 50bp rate hike."

"We can’t take this view with so much time yet to pass....Volatility will likely be around the October and December ECB meetings, but that is months away and tough to trade for right now.”

“The market is too dovish on the Fed considering what is priced in for the ECB."

"Both central banks need to hike interest rates and both are likely still to be underestimating the inflation outlook. But the relative difference between the two is the odd part for FX – 239bp is priced in for the ECB over the next three years versus 202bp for the Fed. This is partly because the Fed has already hiked rates by 75bp.”

“In FX strategy we add to our existing EUR downside exposure with short EUR/USD in spot.”

Chris Turner, global head of markets and regional head of research for UK & CEE at ING

“We think the European Central Bank (ECB) will be disappointed by the euro's reaction yesterday."

"We had felt that the hawkishness seen since late April had been an effort to narrow rate differentials with the US and to get EUR/USD higher.”

“As Francesco Pesole wrote at the time, the weak link was peripheral debt markets being left unprotected without sufficient news on anti-fragmentation support packages.”

“One also sensed that, as a pro-cyclical currency, the euro may not appreciate rate hikes as growth forecasts are cut."

“There also seems to be the start of a risk premium being built into the euro now - i.e. EUR/USD is trading some 1.5/2.0% lower than where short-term fair value models suggest.” 

“For today, a firm US CPI print and higher short-term US rates could break EUR/USD below 1.0600 in a move to the 1.0500/0520 area. We also favour EUR/CHF lower from these levels”

Mazen Issa, senior FX strategist, TD Securities 

“Following the ECB decision to reaffirm a 25bp hike in July and acknowledge a likely scenario of a 50bp hike in September, we think risk/reward has shifted to the downside for EURUSD.”

“There are only 4 meetings left this year and the ECB has already pre-committed to doing 25bp and 50bp for half of them. The curve currently reflects 140bp of tightening by year-end which leaves limited optionality from there

“Tactically, we see growing signs of an adverse risk backdrop in the coming weeks, as US real rates and equity correlations wane further and the USD peels away from relative US equity performance. 

“That is an environment that could see more USD resilience in the very short-term especially if US core CPI surprises to the upside.”

“We add a short EURUSD position to our FX Model Portfolio. We target a move to 1.05”

Lee Hardman, currency analyst, MUFG

"The ECB sent a clear signal yesterday that they plan to deliver a series of rate hikes in an attempt to dampen upside risks to inflation. We now expect the ECB to deliver a 25bps rate hike in July followed by a 50bps rate hike in September which will quickly bring an end to negative rat policy in the euro-zone."

"The ECB did not go into more detail over how far rates may need to be raised at the current juncture, but did indicate that would be discussed in more detail at upcoming meetings. The updated guidance has encouraged European rate markets to price in the ECB raising the policy rate closer to 2.00%."

“The higher yields on offer in the eurozone should offer the euro more support with spreads continuing the recent narrowing trend. However, the scale of ECB tightening now expected will also threaten the euro-zone economic recovery.”

“It was notable again yesterday that yields rose more sharply in more fiscally challenged euro-zone countries. It reflected some disappointment as well that the ECB did not provide stronger guidance on how it plans to deal with fragmentation risk as it moves to tighten policy.” 

Joseph Capurso, head of international economics, Commonwealth Bank of Australia

"EUR/USD slumped by more than 150bp to 1.0611 after the ECB’s post-meeting press conference. European bonds sold-off partly because the ECB is not planning at this stage to take concrete measures to curtail the widening in Eurozone periphery sovereign bond yield spreads versus Germany."

"Instead, ECB President Christine Lagarde pointed out again the ECB stands ready to deploy either existing or new instruments to deal with Eurozone fragmentation risks."

"The decrease in most commodity prices, the decrease in US and European equity markets, and the weakening in EUR and CNH contributed to AUD’s weakness. Chinese President Xi’s reiteration of the covid zero policy is a bigweight on AUD because it constrains the Chinese economic recovery. AUD/USD could test 0.70 again in the next week."