ECB hikes interest rates by 25bp to bring deposit rate to 2.5%
The ECB's decision to hike interest rates by 25 basis points, bringing the deposit rate to 2.5%, reflects a proactive stance against inflation risks, particularly in light of escalating energy prices due to geopolitical tensions in the Middle East. Per the full note from ing-think, this rate increase is characterized as an 'insurance' measure aimed at preventing potential second-round effects on inflation, even as current core inflation metrics remain stable. Market expectations are now recalibrating as this tightening aligns with a slight upward revision in growth forecasts to 0.9% for this year. With no upcoming influential events on the calendar, how the Euro responds to this hike and bond yields will be crucial in the coming weeks.
What the desk is arguing
The ECB's latest rate hike is a clear commitment to curbing underlying inflation and to stay ahead of market dynamics. As noted in the recent commentary, this hike is positioned as an 'insurance' measure, reflecting the ECB's vigilance amid rising energy costs triggered by geopolitical unrest.
This action comes despite core inflation readings suggesting minimal immediate risk from higher energy prices, reiterating that the central bank is tasked with balancing inflation and growth expectations. Current forecasts still project inflation at 3% for this year, with slight upward adjustments for the following years, indicating that the ECB anticipates the need for further adjustments in its policy stance.
Where it sits in our coverage
Our consensus target for EUR/USD is currently set at 1.075, with a range from 1.04 to 1.12. Key firms contributing to our coverage include: - jpmorgan: target of 1.10 - bofa: target of 1.04 - citi: target of 1.08
This outlook is aligned with jpmorgan, indicating a more optimistic view towards a stronger Euro, while diverging from bofa, which maintains a more cautious stance. This positioning places our call at the upper end of the established spread.
How other firms see it
The market is somewhat split at this moment; firms like jpmorgan and citi agree on a strengthened Euro outlook, while bofa expresses a contrary view anticipating lower valuations. This discrepancy highlights the divisions in sentiment post-rate hike.
Other related pairs to watch include EUR/GBP as UK monetary policy decisions unfold, potentially influencing the Euro's relative performance in the context of broadening market reactions to changes in interest rates. Additionally, monitoring EUR/JPY could provide insights into cross-border capital flows in response to differing yield curves.
How firms align with this view
Aligned with the desk view
Contrary positioning
Key takeaways
- 01ECB hikes by 25bps to 2.5%, marking a firm stance against inflation risks.
- 02The decision aligns with upward revisions in growth forecasts amid geopolitical energy pressures.
- 03Market realignment is expected, as firms diverge on EUR/USD targets.
- 04Key firms project differing strengths of the Euro against the USD.
Market implications
Watch for EUR/USD to react around the 1.08 mark, as traders assess the implications of the rate hike against broader economic indicators. Position shifts may occur as traders recalibrate forecasts based on the ECB's latest moves and alignments within the central bank policy framework.
Risks to this view
A shift in global economic conditions, particularly related to energy prices or geopolitical stability, could undermine the ECB's tightening narrative. Additionally, if inflation metrics deviate significantly from current forecasts, a reversal of market sentiment could challenge the Euro's recent gains.
Older quick take Quick take Published 10:47 ECB hikes interest rates by 25bp to bring deposit rate to 2.5% The European Central Bank has hiked interest rates by 25bp. At 2.5%, the main policy rate is now at the upper bound of what the central bank considers its neutral interest-rate range The ECB hiked rates by 25bp today, as expected Share X LinkedIn E-mail Copy link Share X LinkedIn E-mail Copy link Download Carsten Brzeski Global Head of Macro They might not like the term, but the just-announced second rate hike, bringing the ECB’s deposit rate to 2.5%, still falls into the category of an ‘insurance' rate hike. Or to put it in terms the Bank might prefer, it is a hike to stay ahead of the curve, demonstrating the ECB’s high level of vigilance, and an attempt to prevent higher energy prices from feeding through to the broader economy.
While the stage was set for a rate hike, even under a more benign energy price outlook, the recent escalation in the Middle East and surge in oil prices have clearly strengthened the case for an increase. This is despite the fact that other inflation measures, like core and services as well as survey-based inflation expectations, still suggest there are hardly any second-round effects from higher energy prices. This picture is mainly reflected in the newest round of staff projections, which show inflation unchanged at 3% this year.
For 2027 and 2028, the inflation forecast was revised upwards to 2.5% and 2.1%, respectively. Core inflation is expected to come in at 2.5%, 2.6% and 2.3% in 2026, 2027 and 2028, respectively. Growth was revised upwards slightly to 0.9% this year and 1.4% in 2027 (and 1.5% in 2028).
Don't forget that the recent surge in bond yields and oil prices has not been fully incorporated in these forecasts. With the latest developments, today’s rate hike was almost a no-brainer and not controversial. In light of higher actual and projected headline inflation, bringing the policy rate to the upper end of the range that the ECB itself calls 'neutral' did not pose any risk of being too activist or too restrictive.
The harm of doing nothing, at least for the ECB’s credibility, is clearly larger. However, looking beyond today’s hike paints a very different picture and is much more complicated. Going further would mean that the ECB sees restrictive monetary policy as necessary.
But there is a big difference between an economy that has shown resilience, and an overheating economy that needs restrictive monetary policy. We still find it hard to see – amid public finance woes and surging bond yields – that the ECB would really be willing to add more fuel to the fire. In other words, it's difficult to envisage the ECB being willing to risk a recession to tackle what is still a textbook supply-side shock.
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