ECB decision
Later today the European Central Bank is scheduled to deliver its latest monetary policy decision. As a recap, the central bank has spent the last year publishing 10 back-to-back hikes to the benchmark rates within its suite of monetary policy tools. Today, however, it seems almost certain that European policy makers call time on this cycle and elect for a hold in rates. There is little doubt that Europe still has a significant inflation problem. However, the narrative from the central bank and market has suggested that in the view of policy makers, and mimicking other central banks ahead of it, it’s time for a pause from the ECB.
That will leave the Eurozone benchmark deposit policy rate at 4%. Close observers of ECB policy will note an array of rates higher than 4% in the ECB’s toolkit. However, it is this deposit rate that is most widely quoted and most comparable to the BoE’s ‘bank rate’ and the Fed Funds target band. The challenge for the Euro will be as follows. With a target band of 5.25-5.5% at the Fed, transatlantic interest rate differentials at the policy level are relatively contained. However, investors’ recent selling frenzy within US debt instruments has widened the perceived policy divergence underlying the Euro and US Dollar. We have seen longer dated market pricing of fixed income products be the driver of spot and forward FX pricing, not policy rates. A pause at the central bank level today is unlikely to do any favours for such fixed income pricing but may insulate the Euro in the absence of the rhetoric surrounding the discussion.
Those who have followed recent releases from the ECB will also note the theme of policy wording and press conferences having a negative impact upon the Euro. Encouraging bond buying and a decline in rate expectations, the discussion following recent decisions has proved detrimental to the Euro. Despite the level we see the Euro at today, investors will struggle not to be mindful of Lagarde’s recent propensity to talk down the Euro. Lastly, whilst a hold might allow Lagarde to skirt too much concentrated discussion on the deposit rate, the myriad of monetary tools deployed by the ECB in recent years and their continuing legacy and impact could be up for discussion. If the ECB chooses to address its multifaceted QE hangover, for example, we could see markets take swift action.
Discussion and Analysis by Charles Porter
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