ECB preview: a hawkish hold is expected but there's risk of a disappointment
The European Central Bank (ECB) is poised to maintain its policy rate at 2.00% amid a backdrop of rising inflation and mixed economic signals, suggesting a cautious approach moving forward. Per the full note source, the ECB's forward guidance is expected to remain non-committal, emphasizing a data-dependent stance. Market participants are particularly focused on the press conference for insights into the ECB's reaction function, especially given the recent increase in headline inflation driven by energy prices. The market is currently pricing in 80 basis points of tightening by year-end, with a high probability of a June rate hike, which may lead to disappointment if the ECB adopts a less hawkish tone than anticipated.
What the desk is arguing
The desk believes that while the ECB is likely to hold rates steady today, the potential for a less hawkish tone could weigh on the euro. This perspective is supported by the recent economic data, including a deterioration in the Flash Services PMI and a modest rise in wage growth expectations to 2.8% from 3.1%. Per the full note source, the ECB's recent commentary suggests a cautious approach, with President Lagarde indicating the bank is not in a rush to tighten policy.
The economic backdrop shows rising inflation expectations, particularly in the short term, but with limited impact on the long-term outlook. The Flash CPI data for April is expected to show further increases in headline inflation, yet core inflation remains stable, indicating that the ECB may not feel pressured to act aggressively. This nuanced view creates a risk of disappointment for hawkish market participants who are betting on a more aggressive tightening cycle.
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 closely with jpmorgan, which reflects a similar outlook, while it diverges from bofa, which is positioned at the lower end of the range. The desk's call sits at the upper bound of the spread, indicating a more optimistic view on euro strength relative to some peers.
How other firms see it
Firms like jpmorgan and citi are aligned with the expectation of a cautious ECB, anticipating that the central bank will maintain its current stance while monitoring economic data closely. Conversely, bofa holds a more bearish outlook, suggesting that the euro may face downward pressure in the near term.
Traders should also keep an eye on related currency pairs such as EUR/GBP and EUR/JPY, which may reflect broader market sentiment towards the euro in light of ECB decisions and economic data releases.
What the calendar says
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The European Central Bank is expected to maintain its policy rate at 2.00% today and keep the non-committal forward guidance by following a “data-dependent" and "meeting-by-meeting" approach. The focus will be mainly on the press conference where market participants will look for clues on the next ECB's move, what the ECB's reaction function will be and how the Governing Council is viewing the current situation. Since the last ECB meeting, the economic data confirmed the expected increase in headline inflation due to the energy shock and the negative impact on growth.
Today, we will get the Eurozone Flash CPI for April where headline inflation is expected to increase further but with still limited impact on the core measure. The latest ECB's SAFE survey showed rising inflation expectations in the short-term but no impact on the long-term outlook. Wage growth expectations have also moderated to 2.8% vs 3.1% in the prior quarter.
We recently saw further deterioration in the Flash Services PMI for April which fell to a 62-month low, while Manufacturing PMI was artificially boosted by stock-building with weak underlying details. What caught everyone's eye was of course the inflation section. The agency noted that “inflationary pressures continued to strengthen, with both input costs and output prices rising at the sharpest rates in more than three years amid the impacts of the war in the Middle East".
If we look at the ECB commentary leading up to today's decision, President Lagarde recently said that they are between the baseline and adverse scenario and that the ECB doesn't have a tightening bias. ECB's Schnabel, who's generally the most hawkish member when there are inflation risks, said that the ECB is not in a rush and can afford to take time to analyse better the current shock. Given the economic data and the recent ECB commentary, there's a risk of disappointment for the hawks.
The market is pricing 80 bps of tightening by year-end with an 87% probability of a rate hike in June. It's going to be hard for Lagarde to "outhawk" market's expectations, so just a less hawkish tone and a more measured approach to rate hikes could weigh on the euro. Even if Lagarde pre-commits to a rate hike in June, the upside in the euro is unlikely to be sustained given the already strong hawkish pricing.
This article was written by Giuseppe Dellamotta at investinglive.com.
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