Hawkish European Central Bank Policy Prescription Helps EUR/USD Rate

"The Governing Council decided to raise interest rates today, and expects to raise them significantly further, because inflation remains far too high and is projected to stay above the target for too long" - European Central Bank 

© European Central Bank, reproduced under CC licensing

The Euro pared earlier losses against the Dollar and did some of the work driving a rally in EUR/GBP after the European Central Bank (ECB) raised its forecasts for inflation in the Eurozone before writing a hawkish prescription of "significantly" higher borrowing costs in response.

Europe's single currency was left trading higher against most currencies on Thursday after the ECB said annual inflation is now expected to be higher over the coming years before being left sitting at a level slightly above the 2% target around the end of the forecast horizon.

This was the chief reason cited for another warning that the Governing Council expects to raise European interest rates further even after its decision to lift all benchmarks for borrowing costs by a further half percentage point, taking the once-negative deposit rate up to 2.5%, from -0.5% in July. 

"The key ECB interest rates are the Governing Council’s primary tool for setting the monetary policy stance.  The Governing Council today also discussed principles for normalising the Eurosystem’s monetary policy securities holdings," the bank said in its statement.

In another significant step toward policy normalisation the ECB also said it would begin the process known as quantitative tightening (QT) from March.

Above: Euro to Dollar rate shown at hourly intervals alongsie EUR/GBP.

Here it will cease reinvesting some of the money it receives from governments when bonds bought under its quantitative easing programme reach maturity. 

Through this process the ECB intends to at least partially extricate itself from the local government bond markets though the pace of decline in its asset holdings will be limited to €15 billion per month until the end of the second quarter, after which point the Governing Council will make another decision. 

"The Governing Council decided to raise interest rates today, and expects to raise them significantly further, because inflation remains far too high and is projected to stay above the target for too long," the bank also said. 

Eurozone inflation is now seen averaging 8.4% in 2022 before falling to 6.3% next year, reflecting increases from 8.1% and 5.5% back in September, while the projection for 2024 was lifted from 2.3% to 3.4%.

In addition, the ECB still sees the Eurozone rate of inflation sitting around 2.3% at the other end of its forecast horizon in 2025 while the pace of price growth is expected to be a higher 2.4% after energy and food prices are removed from the basket of goods for which prices are analysed.

Source: Netdania Markets. To optimise the timing of international payments you could consider setting a free FX rate alert here.