ECB debrief: Shifting expectations

The surprise delivered at last week’s European Central Bank meeting was more than enough for markets to brush aside the Federal Reserve’s recent ‘hawkish pivot’ as background noise. Indeed, with the bell tolling for ultra-easy monetary policy, we could be entering a period of seismic global change—it’s only taken rampant inflation to get us there.

Although much of the language stayed the same, European Central Bank President Christine Lagarde refused to rule out a 2022 rate hike, with the governing council showing little tolerance towards higher prices. The central bank’s hawkish pivot was underpinned by a 3% gain for the Euro against the US Dollar and a 2% gain against the Pound to end the week. Meanwhile, European bond yields rose at a pace not seen for years. Just this morning, ECB member Klass Knot mentioned that the bank’s first rate rise could come as early as Q3 this year, a marked shift in rhetoric for an institution that hasn’t raised rates since 2011. Meanwhile, traders and economists have now aligned on the expectation that the ECB will deliver two 25bps rate hikes by the end of the year, bringing an end to seven years of negative rates.

The risks for the ECB are clear. Although it’s spent a decade trying to lift persistently low inflation, it doesn’t want to be seen as behind the curve, in the same vein as the Federal Reserve or the Bank of England. Yes, it will likely update inflation expectations sharply higher in its March 10th quarterly economic review but should err on the side of caution when it comes to signalling outright policy tightening.

Bottom line: We concede that inflation is rampant right now, but our base case is still that markets have gotten carried away over rate expectations. The possibility exists that come H2, ultra-hawkish rate expectations will have to scale back if inflation begins to soften. That leaves room for risk assets to take another leg higher. Nevertheless, we see short-term demand for the Euro remaining, mirroring the price action of H2 2020—at least until the ECB meets again in March.

The week ahead
 

GBP 

The Pound performed well against the US Dollar last week, gaining 0.56% as the Bank of England opted to raise interest rates to 0.50%. Sterling retraced highs last seen in early 2020 as a hawkish pivot from the European Central Bank prompted markets to price in interest rate hikes on the continent for the end of the year. BoE Governor Andrew Bailey has come under fire for encouraging people not to seek a pay rise which he says risks fueling inflation further, despite dithering over the tightening of monetary policy according to Economist Gerard Lyons. House prices in the UK grew at the slowest pace since June last year as the first signs of market normalisation emerge.  

  • The Halifax House Price Index m/m for January came in at 0.30% versus analyst estimates of 0.90%.
  • Monetary Policy Committee member and Bank of England Chief Economist Huw Pill will be speaking on Wednesday at 1:10PM.
  • Bank of England Governor Andrew Bailey will be speaking this Thursday at 8:05PM.
  • Preliminary Gross Domestic Product q/q data for the fourth quarter of 2021 is expected to read 1.10%.

 

EUR

EUR/USD climbed around 2.50% last week, and Eurozone bonds sold off sharply as European Central Bank President Christine Lagarde hinted to markets the potential for more hawkish monetary policy action in the coming months. The German ten-year and five-year bond yields jumped to three-year highs amid the selling pressure. French President Emmanuel Macron will be heading to Russia today in an attempt to engage in diplomatic negotiations with Vladimir Putin to try and defuse the current tensions surrounding Ukraine. Meanwhile, German Chancellor Olaf Scholz will be heading to the United States in an attempt to rebuild credibility after scepticism over the country’s response to the crisis.  

  • German Industrial Production m/m declined by 0.30% in December compared with a 0.30% gain in November.
  • European Central Bank President Christine Lagarde will be speaking today before the European Parliament Economic and Monetary Affairs Committee at 3:45PM.
  • The latest European Union Economic Forecasts will be released this Thursday.
  • To finish the week, final German Consumer Price Index m/m data for January will be published.

 

USD

The US Dollar Index drifted 1.80% lower last week amid a wave of hawkish sentiment from the UK and Europe. The S&P 500 managed to close out the week higher on Friday, fuelled by a large upside surprise on Non-Farm Payrolls and despite a slew of mixed earnings results in what was a volatile week for markets. The temporary jump in Coronavirus cases over the Christmas period didn’t appear to impact employment, with gains appearing across all sectors. Job openings have also climbed as the effects of Covid on the labour market start to appear more distant.

  • Federal Open Market Committee members Michelle Bowman and Loretta Mester are due to speak this Wednesday at 3:30PM and 5:00PM, respectively.
  • US Consumer Price Index and Core CPI m/m for January is forecast to come in at 0.40% and 0.50%, respectively. December readings came in at 0.50% and 0.60%.
  • US Unemployment Claims for the week ending the 5th of February are projected to print at 227K versus 238K in the week prior.
  • Preliminary University of Michigan Consumer Sentiment looks little changed this month, with analysts pointing to a 67.7 print.

 

If you'd like to discuss your foreign exchange requirements with one of our currency specialists, call us on +44 (0)20 3465 8200.