Today’s ECB rate statement offered markets very little to reprice. The only tweak from December came in the penultimate paragraph, where wording around adjusting policy in “either direction” was removed.
In isolation, the tweak to the policy statement was very minor and the non-existent market reaction was telling. However, it foreshadowed the big shift in the central bank’s tone on policy normalisation that was to come in the press conference. Shortly after taking the stage, President Lagarde referenced the near-term risks to the central bank’s inflation forecasts and the “unanimous concern about inflation data” among the Governing Council. Lagarde went on to outline how the March and June meeting would be instrumental for future policy as greater consideration will be paid to the medium-term inflation outlook and the risks to that, paving the way for a potential shift in overall policy.
Given the emphasis on policymakers’ concerns over rising inflation, however, it is more likely that March will present a substantial policy change, should the ECB assess a broadening in the inflation pressure driven by higher negotiated wages and increasing second-round effects.
If this starts to become visible, it is likely that the ECB will increase the pace in which it winds down its post-PEPP transition and begins to signal to markets that a rate hike in Q4 is likely – President Lagarde already alluded to this by refusing to reiterate her December view that rates won’t rise in 2022.
This change in tone took markets by surprise, as expectations heading into today’s decision were for the central bank to reference the upside risks to near-term inflation and to push back market expectations on rate hikes, not embolden them.
With Lagarde noting that they are “getting much closer to target” and the dovish central bank showing initial signs of movement, the euro is likely to remain supported around the 1.14 level. Consolidation around these levels and a potential break higher to year-to-date highs is largely depending on incoming US data, namely tomorrow’s payrolls figures. A further narrowing in yield differentials on the back of a weak labour market report, which shows not only a contraction in the employment level but also cooling wage growth, will likely shake euro bears out of the market. A stronger euro could do the ECB’s dirty work for them, strengthening their terms of trade and easing some pressure from USD denominated energy imports.
EURUSD jumps higher as the ECB starts to stretch its hawkish wings after the ice age, markets speculate on 40bps of rate hikes this year
Author: Simon Harvey, Head of FX Analysis