Get ready for the ECB to hike rates (just not tomorrow)

Matt Simpson financial analyst
By : ,  Market Analyst

There has been a growing chorus of calls for the ECB to hike rates, but they’re unlikely to raise rates this week. Tomorrow’s meeting is really about formally announcing the end of asset purchases and signalling that hikes will begin in July. And whilst it would be a welcomed bonus for the ECB to announce the size of July’s hike, we’re not holding our breath.

 

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Will the ECB hike in 25 or 50-bps increments?

Forecasters are divided between 25 and 50-bps increments, and we cannot blame them. There are no immediate signs of inflation pausing for breath using the headline CPI numbers. Monthly and annualised CPI reads pointing sharply higher for France, Germany and the broader euro zone - and that alone calls for the ECB to join the rate-hike party, especially since the latest trend is now 50-bps increments.

 

Yet as ECB President Lagarde herself points out - the euro area isn’t facing excessive demand or an overheating economy, and large parts of inflation have been imported from outside the euro area. Ultimately this is weighing on consumer and business sentiment, so a series of 50-bps hikes seems unlikely, despite high levels of inflation.

 

In all likelihood the ECB will opt to raise rates by 25-bps in July and September, which leaves the potential for further hikes in October and December. They want to be seen acting, but are clearly happy to be one of the last out of the gates. And whether they’ll switch to a 50-bps increment is likely down to whether inflation begins to cool in H2.

 

ECB guide

 

Eurozone inflation remains hot, but there are early signs of it cooling

But there are some signs that inflation pressures may be abating. Expectations for consumer inflation and selling prices for the eurozone fell notably in May, along with German producer prices and import costs. Still, it’s unlikely to change the needle tomorrow. The ECB appear set to announce a July hike, although we’ll likely need to wait before finding out just how aggressive said hikes will be.

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EUR/USD meanders around 1.7000 ahead of ECB meeting and US CPI

One issue euro bulls may now face is that any forthcoming hike from the ECB has been well telegraphed, and that leaves room for disappointment (and a lower euro). Of course, another rise in US inflation on Friday would likely exacerbate any downside move on EUR/USD. But, if the ECB surprises with hawkish forward guidance tomorrow and it is coupled with another soft(er) inflation report on Friday for the US, we’d expect a decent rally above 1.0800.

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The risk leading up to the ECB meeting is that EUR/USD remains within its approximate 1.6350 – 1.7800 range. Yet that still leaves potential opportunities for those seeking smaller moves.

EUR/USD is trading below 1.0700 and the weekly pivot point ahead of the European open, so today’s bias remains bearish whilst it caps as resistance. The lows around 1.0650 would become our downside target, where bulls may seek to enter as part of a range-trading strategy ahead of the ECB meeting. Conversely, a break above yesterday’s high today flips us to a bullish bias over the near-term and brings 1.0750 into focus. Whereas a disappointing ECB meeting coupled with stong(er) US inflation could see EUR/USD roll over after breaking out of range.

 

 

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