The euro rose 0.26% against the dollar last week (EUR/USD), marking the first weekly gain in around a month ahead of the European Central Bank (ECB) rate decision on Thursday, June 15. The European markets had a positive day on Tuesday, with the German 40 (FDAX) index recording a tiny gain of 0.06% and the FTSE 100 (UK 100) rising by 0.32%.
The ECB is expected to raise interest rates by a quarter of a point when it meets on Thursday. However, uncertainty over how much higher the interest rate will go persists after inflation in the Euro Area fell more than expected in May, and the economy fell into recession over the winter.
Analysts predict that a 25 basis point rate hike is a "done deal", expecting the ECB to ignore disappointing growth and a growingly gloomy economic outlook. The economic data published since the last meeting on May 4 favour doves as inflation slowed but remained comfortably away from the 2% target at 6.1%. Moreover, analysts believe the ECB will favour higher rates.
The Bigger Picture
The expected quarter-point interest rate hike would put the key deposit rate at 3.5%, the highest since 2001. The ECB has been on an unprecedented rate hiking campaign since the middle of last year, in which it has already tightened by 375 basis points. Despite this aggressive action, headline inflation remains well out of the range where the ECB can ease up, implying the focus of the ECB's meeting may be on any indication of when rates may peak.
The inflation rate in the Eurozone is at 6.1%, over triple the ECB's target of 2%. While that is lower than the 10.6% peak last October, headline inflation is anticipated to stay above target at least through 2025, according to a poll of economists. Core inflation is also expected to remain above target for the rest of the year due to wage inflation and a hot jobs market.
What Are ECB Members Saying?
As recently as June 1, ECB's President Christine Lagarde stated that inflation was too high, despite increasing evidence showing that rate hikes implemented so far function against rising inflation. In fact, the interpretation from the minutes of the last meeting is that ECB members essentially promise that the bank will hike at the next meeting.
Some policymakers have already said another rate hike is in the cards for the July 27 meeting. The problem is that underlying price growth remains high, and there is no clear evidence that it has peaked, according to the ECB President.
Accordingly, this should bring the focus of Thursday's event on the President's post-rate decision press conference, as the market currently is pricing in a 25bps hike at the next meeting in July, and traders will want to see how the fortunes may change. (Source:Reuters)
What Economists' Forecast?
Around three-quarters of economists in a recent Reuters poll agree with the market and expect a quarter-point rate hike in July. Most economists also expect the ECB to keep rates unchanged for the rest of the year once they reach the peak rate. In addition, they say that the simple explanation for this is that inflation has not come down enough.
In another poll conducted by Bloomberg, economists appear nearly unanimous that the ECB will hike again in July. After that, the vast majority of the economists also see rates staying steady, anticipating that there will be no major change in the ECB's outlook. The market is expected to focus on the guidance through the new staff projections, which could be tweaked after it was reported last Thursday that the Euro Area slipped into recession last winter. However, several economists say that with expectations for June and July rate hikes already established, the possible shift in course for the ECB will be in September.
The EUR/USD pair hit a three-week high overnight on Wednesday in anticipation of the ECB rate decision on Thursday, and the ECB is expected to hike interest rates despite falling into recession. However, whether or not the central bank will indeed embark on another rate hike is yet to be seen. Traders will only find out following the meeting.