ECB policymaker Nagel says more appropriate to respond in June if outlook does not improve
The desk believes that the ECB's current communication strategy signals a precarious balancing act between addressing inflation and maintaining economic stability. Per the full note source, ECB policymaker Nagel's comments highlight a potential June rate hike, with market expectations pricing in a 75% chance of such a move. This aligns with our view that the ECB may be forced to act more decisively if economic conditions do not improve, despite concerns over the effectiveness of monetary policy in addressing supply shocks. The consensus among firms suggests a target range for EUR/USD that reflects these dynamics, with key data points on the horizon that could influence market sentiment.
What the desk is arguing
The desk argues that the ECB's cautious approach to monetary policy, as articulated by Nagel, underscores the challenges of responding to persistent inflation without exacerbating economic downturns. Per the full note source, the expectation of a June rate hike is gaining traction, with traders pricing in approximately 70 basis points of hikes by year-end.
This scenario reflects a broader concern that the ECB is relying on market forces to tighten conditions rather than taking decisive action. The current deposit facility rate of 2.00% is seen as neutral, yet any hikes below 100 basis points may only marginally tighten conditions, leaving inflation unaddressed.
Where it sits in our coverage
Our consensus target for EUR/USD is 1.075, with a range from 1.04 to 1.12. Notable firm targets include: - jpmorgan: 1.10 (Mar26) - bofa: 1.04 (Mar26) - citi: 1.12 (Mar26)
This view aligns with jpmorgan, which anticipates a more aggressive ECB response, while bofa holds a more conservative stance at the lower end of the range. The desk's call is positioned at the upper bound of the consensus spread, indicating a belief in stronger EUR performance.
How other firms see it
Firms such as jpmorgan and citi are aligned in their expectations of a more hawkish ECB, anticipating that inflationary pressures will necessitate significant rate hikes. Conversely, bofa remains skeptical, suggesting that the ECB may not act decisively enough to combat inflation effectively.
Traders should also watch the EUR/USD trajectory closely, as it reflects the broader implications of ECB policy shifts. Additionally, the interplay between ECB actions and the Fed's monetary stance will be critical in shaping market dynamics.
What the calendar says
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Should not forget that baseline scenario already entails a more restrictive monetary policy It would be more appropriate to respond in June if outlook does not improve markedly Well, this just reaffirms the report from yesterday that policymakers were converging towards a June rate hike. The report even suggested that some policymakers were already on board with perhaps even "two rate hikes" being needed to address the situation. Again, there's a lot that I do not like with how the ECB is choosing to respond here.
The first thing is that this kind of communication means that they are seeing markets do the tightening for them - to some extent. Traders are now seeing ~75% odds of a move in June with ~70 bps of rate hikes priced in by year-end. If the ECB does not deliver on that, then we'll see financial conditions loosen and they risk a policy misstep in second-round effects get out of control.
The next thing is that monetary policy is not well equipped to deal with a supply shock, especially the kind we're seeing. If the ECB is just advocating token rate hikes just because, then that's just poor form. The deposit facility rate now is at 2.00% and it fits with where they see "neutral" as being. 50 bps or even 75 bps of rate hikes will just bring things to being marginally or slightly restrictive at best.
So if their goal is to really rein in inflation, they will have to do much more than that. The question is with economic conditions set to face a hard struggle, do they have the stomach to raise interest rates by that much and put added pressure on the economy? Damned if you do, damned if you don't I guess .
This article was written by Justin Low at investinglive.com.
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