The ECB today raised its three key interest rates by 25bps, bringing the marginal lending facility to 4.5%, the refinancing rate to 4.25% and the deposit rate to 3.75%.
The decision on rates met our expectations and those by the majority within the market, with a strong consensus forming after President Lagarde telegraphed such actions back in June. In a similar vein to the Fed, the ECB’s accompanying rate statement consisted of very few edits from the previous edition, although the tweaks made were dovish on the margin and aimed at achieving maximum optionality. With regards to inflation, the ECB now acknowledges that some underlying measures are easing and expects inflation to drop further over the remainder of the year, although this was caveated by the fact that inflation “remains high overall” and “will stay above target for an extended period of time”. While this is a material change to the language around the outlook for price growth, it doesn’t deviate from the view taken by President Lagarde back at June’s meeting when she guided markets towards another 25bp hike at this meeting due to inflation not coming down in a “timely manner”. In this context, it is actually the change in language around the overall calibration of the ECB’s monetary stance that provides the most dovish development. The Governing Council will now base future interest rate decisions such that policy is “set at sufficiently restrictive levels” as opposed to interest rates being “brought to levels sufficiently restrictive”. While slight, the change of language was official confirmation that the ECB deems itself either at or very close to its terminal rate of interest, an interpretation that was sought by the central bank with President Lagarde stating that the change in verb wasn’t “random or irrelevant”.
At the risk of being subject to confirmation bias, we view today’s ECB decision as markedly more dovish.
Not only has the language in the official statement been tweaked to be less committal, but President Lagarde also avoided providing any explicit guidance on the September meeting and beyond. The more neutral communication by Lagarde, aimed at retaining maximum optionality, stands in stark contrast to the June meeting where she pre-announced a July hike in the press conference and builds upon the growing chorus of more dovish ECB communications in recent weeks. On the whole, today’s meeting reinforces our view that the ECB has likely conducted its last hike of this cycle. After a year-long sabbatical, we think the doves will finally hold a more commanding position within the Governing Council come September.
While the ECB’s decision today doesn’t necessarily contrast too heavily with the Fed’s last night, we believe the risks of an extension in the hiking cycle to be greater in the US than the eurozone.
This is primarily due to the fact that growth conditions are more resilient in North America, raising the prospect of increased inflation persistence. This view has been shared by market participants today, especially as the advanced Q2 GDP reading out of the US showed the economy continued to operate above the Fed’s estimated potential level of output. Eurozone rates have steadily fallen over the course of the ECB decision in the range of 7-10bps, whereas the US 2-year now sits 3.5bps higher on the day. For EURUSD, we expect the re-widening in nominal interest rate differentials to continue driving the pair back below the 1.10 level. While traders have flirted with this outcome already this afternoon, we expect the decline to be more sustainable tomorrow once French GDP data undershoots expectations and Spain’s preliminary CPI report for July points towards sustained disinflation in the euro-area as a whole.
A re-widening in US-Eurozone rate differentials leads EURUSD to test the 1.10 handle
Simon Harvey, Head of FX Analysis