After being much touted in the previous meeting and successive hawkish rhetoric from ECB President Lagarde in recent weeks, the ECB has hiked its rates corridor by 25 basis points. That much was expected. However, this is still being seen as a hawkish hike amid a sharp increase in inflation projections. If this runs true, then the ECB looks set to continue hiking throughout the summer. However, the incoming economic data will tip the balance.
- Key ECB decisions reflect a “hawkish hike”
- Inflation projections are key, but are they justified?
- EUR builds support, for now
- DAX futures continue to struggle
ECB hikes by 25basis points, as expected
It was as expected, but the ECB Governing Council has increased the interest rates corridor by 25 basis points:
- Main refinancing rate up by 25bps to 4.00% (from 3.75%)
- Deposit rate up by 25bps to 3.50% (from 3.25%).
As for comments on rates in the press conference, ECB President Lagarde was very clear:
“Are we done? Have we finished the journey? No. We are not at destination… We still have ground to cover.
She went on to add:
“It is very likely that we will continue to increase rates in July… We are not thinking about pausing.”
Inflation is projected to be “too high for too long”
According to the ECB, the dynamics of underlying inflation mean that a hawkish position is necessary. Inflation remains stubbornly high. Inflation projections have been revised higher. The expectations for core HICP have been decisively revised higher:
- Eurozone Core HICP for 2023 is now expected to be 5.1% (up from 4.6% in March)
- Eurozone Core HICP for 2024 is now expected to be 3.0% (up from 2.5% in March)
- Eurozone Core HICP for 2025 is now expected to be 2.3% (up from 2.2% in March)
Inflation projections raised across the board and raise the expectation further above the target of 2%. This is where the hawkish bias is coming from. The ECB will need to continue to hike rates if these projections bear any reality.
However, this hawkish approach to tackling inflation comes as growth forecasts have been revised marginally lower for 2023 (down to 0.9% from 1.0%) and 2024 (down to 1.5% from 1.6% in March). A rather stagnant view of the economy remains in force.
However, what if the inflation projection is too high?
The ECB has significantly increased its inflation projections. Lagarde says that it is due to unit labour costs. However, core inflation is already surprising to the downside. Also, if you look at the PPI data, there is an aggressive decline in the core PPI. The chart below from Vanda shows that the core PPI leads the core consumer inflation by around 9 months. The Core PPI is falling sharply now. It is therefore likely that core consumer inflation will follow in the months to come.
Interestingly, market pricing for ECB rates in front of the decision was looking for a 25bps hike in June and then perhaps one more in July/September. Lagarde’s forthright response on further rate hikes will now see pricing for a July hike come firmly higher. However, much beyond that, the inflation picture may be decisively lower by September. This is further evidenced by the lack of wage pressure. Lagarde said today:
“We are not seeing any spiralling of wages and prices that would cause the second round effect that we would be very concerned about”.
The market reaction seems to be responding to the hike in inflation projections, however, this may only drive a short-term reaction.
EUR crosses are supported, for now
The EUR has found a bid on the back of this ECB decision, and EUR is one of the best-performing major currencies today (only the AUD is outperforming it). Looking at the EUR crosses, there is therefore a decisive rally taking hold. This is most keenly seen in the breakout in EUR/JPY.
The pair has broken above resistance at 151.60 to its highest level since October 2008. Technical analysis shows that momentum is strong in this move, although the RSI is beginning to look stretched. Historically the RSI has struggled to sustain a move above 70 for long before a correction sets in. There is good breakout support initially between 151.07/151.61 whilst the bulls would remain in charge of the rally until a move back below 148.58.
DAX futures ease off slightly
In the equity futures, the European markets have been struggling to keep pace with the big rally in US futures. It is interesting to see the DAX futures easing back today. Technically, there is still an uptrend of the past seven months, coming in around 15850 currently. However, the trend is relatively shallow and momentum is struggling to drive breakouts. Furthermore, the futures have been all but rangebound over the past ten weeks. This ECB decision is sustaining this range.
It may well be that there will still be an upside breakout on the DAX futures as US futures continue to remain strong. However, the concern would come with the lack of intent from the buyers. Any hint of a corrective trigger may see the DAX quickly back towards the trendline again. That will then be a real test of how strong the bulls are.
