A different Euro-vision
A late start to monetary tightening versus the rest of the world could deliver the some-what illusive stronger Euro to markets. A delay to hike rates in Europe has left the ECB playing catch up, with interest rates lagging noticeably behind their peers. Since its inception over 20 years ago, the Eurozone has always had an inflation problem. Far from the global challenge of high inflation rates that we face today, the problem for the Euro area has been a lack of inflation. In fact, Christine Lagarde’s predecessor, Mario Draghi, who spent what is widely regarded as a successful eight years as ECB president, never once had to raise interest rates. With such a well-known anti-inflationary problem, it is no surprise that the Bank was slow to raise rates when inflation was finally ushered in.
Make no mistake, the reluctance to raise rates hurt the Euro immensely. The break of parity within EURUSD was only achievable given the paralysis of the ECB in reacting to rising global inflation and interest rates. Much like the room to catch up in interest rates, EURUSD despite a recent recovery is still far from the levels observed before inflation took hold in early 2021. This residual yet significant Dollar premium could allow EURUSD to move higher whilst the direction of the divergence between the Fed and ECB rates changes direction. You only have to look at a handful of ECB members’ speeches to uncover the appetite and desire for higher interest rates within the governing council. Only yesterday, Bank of Spain Governor Hernández de Cos, widely regarded as one of the more dovish ECB rate setters, spoke of the need to raise rates. The language he used yesterday, stating interest rates will have to “remain in restrictive territory for a long time” should not be taken lightly. Markets will remain vigilant of further ECB speeches scheduled this week.
Discussion and Analysis by Charles Porter
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