Expectations for today’s policy decision by the European Central Bank were at a bare minimum going into the event. Despite the suppressed expectations, the ECB managed to dull the event down even further by adjusting their opening statement such that it indicates the decision would not include an assessment of the economic outlook. The lack of excitement was visible across markets, as EURUSD remained unfazed after the release of the initial rate statement.
In the press conference, President Lagarde gave more clarity on the ECB’s view of the current macroeconomic background, stating that the momentum in the euro area has moderated due to supply shortages and labour imbalances despite the strong recovery.
Beyond this, Lagarde spent a solid amount of time discussing inflation; “We talked about inflation, inflation, inflation.” She reiterated heavily throughout the press conference that inflation is rising primarily because of the surge in energy prices and because demand is outstripping supply, while base effects also contribute to the recent overshooting. However, with inflation expectations now converging closer to the ECB’s 2% target and confidence that price growth will moderate closer to 2% once these transitory factors dissipate, Lagarde outlined that recent CPI readings won’t be enough to force the ECB to tighten policy further just yet. Lagarde also stated market bets on rate hikes are not in line with current guidance, pushing back on aggressive money market pricing which saw 20bps of hikes factored in by Dec 2022 earlier today.
While the ECB communicated that the inflationary overshoot is transitory and that the market pricing of rate hikes is too aggressive, today’s communication was not enough to change courses for FX and bond traders.
The 10Y German Bund yield saw fresh highs while EURUSD rallied throughout the press conference following the dull policy statement. This may be because markets are still too accustomed to Draghi’s focus on the market pricing of ECB policies and view Lagarde’s concerns over the latest money market developments as limited, emboldening market claims that the ECB could raise rates as early as next year – although economists broadly disagree with this view. FX traders now turn to next week’s Federal Reserve meeting where markets’ hawkish pricing will be put to the test, while EURUSD investors may have to wait for tomorrow’s eurozone GDP and CPI data at 11:00 CET to break out of recent ranges.
Charts: Lagarde struggles to talk markets down over rate hikes, causing European yields and EUR to continue rising
Author: Ima Sammani, FX Market Analyst