Market Wrap – Historic ECB Rate Hike

The ECB increased interest rates for the first time in 11 years as expected as the Governing council made its biggest effort yet to fight rampant inflation across the euro zone.

The central bank had previously signalled it would be increasing rates in July and September as consumer prices keep surging. The Frankfurt, Germany, institution had kept rates at in negative territory since 2014, as it dealt with the region’s sovereign debt crisis and the coronavirus pandemic.

Some surprise was seen by market participant by pushing after the central bank increased benchmark rate up by 50 basis points, bringing its deposit rate to zero. Traders had largely expected a smaller hike of 25 basis points.

The ECB policy statement read “The Governing Council judged that it is appropriate to take a larger first step on its policy rate normalisation path than signalled at its previous meeting.”.

The EURUSD pair rose to a session high on news of the more aggressive rate hike, to trade at $1.0257. The yield on the 10-year Italian bond also jumped on the news, which was not surprising.

Investors also kept a keen eye on details regarding the ECB’s new anti-fragmentation tool, which is aimed at supporting those nations with big debt piles starting to build up, such as Italy.

Strangely, earlier today we saw the resignation of Prime Minister Mario Draghi. This was seen as an act of definance against the current inflationary backdrop. Draghi used to President of the ECB.

In terms of what to expect next we probably need to look into the ECB policy statement. The ECB also said that this moves in interest rates “will support the return of inflation to the Governing Council’s medium-term target by strengthening the anchoring of inflation expectations and by ensuring that demand conditions adjust to deliver its inflation target in the medium term.”

It should be noted that the central bank’s inflation target is 2%. Inflation has gone wildly behind this in recent months. The ECB may it cleat it would be increasing rates in September as consumer prices surge.

The bank’s deposit rate is now 0%, the main refinancing operations rate is 0.5% and the marginal lending facility is at 0.75%. This certainly leaves further scope for rate hikes, however, the eurozone banking system is complex.

Most of the gains in the EURUSD pair have been kept, as bulls press against the 1.0200 handle. The EURGBP pair also had a good day on the foreign exchange market as the pound remained pressured.