Morning Brief – ECB Rate Decision Preview

Markets are braced for a bumper rate hike from the ECB this Thursday as the European central bank battle to tame inflation at a time when energy prices are spiralling out of control.

Either a 75-basis point or 50 basis point interest rate hike is seen possible at Thursday’s ECB policy meeting. However, given the deterioration in the inflation outlook a more aggressive hike looks plausible.

Currency traders are currently not bothered about the potential for a rate hike as the euro currency continues to hit fresh 20-year lows against the US dollar currency.

With the British pound in dire trouble on the foreign exchange market the EURGBP pair has been evenly matched, with the cross pair not really picking a direction unlike EURUSD and GBPUSD.

Bond markets have been reacting this week as well as bond traders start to factor in the huge stimulus package from the German government to keep down energy prices.

There is clear divergence between the ECB and FED. The US central bank has hiked rates at the last four Fed meetings this year and is set to continue this trend going into 2023.

The Fed has raised rates by 225 basis points so far this year to a target rate of 2.25% – 2.50% and this rate is now seen peaking at 3.75% – 4.00% in mid-2023.

In contrast, the European Central Bank has raised its three key lending rates by 50 basis points in July, the first-rate hike in over a decade. 

Overall, a 75-basis point hike seems the most likely scenario, with renewed rhetoric from ECB President Lagarde that inflation remains too high. Overall, expect more dramatic action from the ECB on Thursday to fight inflation.

The risk of the ECB earnestly discussing quantitative tightening now seems low given the balancing act of accelerating hikes without spreads blowing out.

Updated inflation forecasts will come with strong upside risks. The base-case will likely show an even greater overshoot in medium-term CPI than previously.

Bond yields have been very volatile in recent weeks. They had jumped on Monday, led by a rise in the Italian 10-yield towards 4%, after Russia’s decision to keep its main gas pipeline to Germany.

Elsewhere, precious metals continued to take a hammering, with the price of gold, silver, and copper all down by over 0.50 percent intraday due to the rising US dollar.