EUR Money Markets: Some signs of tightening conditions
The desk's interpretation suggests that while easing energy prices have effectively removed the prospect of a July rate hike from the European Central Bank (ECB), the potential for tightening in September persists. Per the full note from ing-think, current liquidity remains ample but is showing signs of tightening due to the possible doubling of reserve requirements discussed by the ECB. With the EUR/USD currently at 1.1434, market participants are closely monitoring the ECB's further actions in light of the uncertain geopolitical landscape. This presents a nuanced picture for institutional traders as they brace for the ECB's next steps amidst a rather dovish front end of the rate curve.
What the desk is arguing
The desk frames this as a transitional phase for the ECB in managing monetary policy amid fluctuating energy prices. With energy costs having subsided, fears of inflation are lessened, resulting in reduced immediate expectations for rate hikes, yet the ECB's discourse hints at potential tightening signals for later in the year.
Supportive of the desk’s view is the assertion that liquidity, although currently classified as plentiful, exhibits early signs of strain. A significant point of interest is the ECB's contemplation of increasing reserve requirements; such measures could lead to a more pronounced tightening effect across money market conditions.
The alternative read would be that market participants dismiss the potential for any tightening ahead if energy prices remain stable and inflation consistently reveals no upward surprises. However, the desk emphasizes that potential geopolitical shifts, particularly relating to the Middle East's stability, could trigger increased volatility.
Where it sits in our coverage
Our current consensus for the EUR/USD stands at 1.1434, with a median projection across firms pointing to 1.2000 by December 2026. Notable targets from key firms include: - citi: Dec26 1.1200 - goldman: Dec26 1.2000 - hsbc: Dec26 1.1800
The desk's assessment aligns with the upper end of the current consensus targeting for December 2026 while acknowledging varied forecasts, particularly from citi, which positions significantly lower than others at 1.1200.
How other firms see it
Aligned firms, like goldman and hsbc, share the desk's outlook on maintaining a bullish perspective for the EUR/USD toward the latter half of the year. Conversely, firms like citi present a more conservative stance, projecting lower prices.
Traders should also closely observe correlated pairs like USD/JPY, as shifts in ECB policy, particularly around rates, will reflect on USD dynamics and broader market sentiment.
How firms align with this view
Aligned with the desk view
Contrary positioning
Key takeaways
- 01The ECB is unlikely to hike rates in July but signals a tightening potential in September.
- 02Liquidity conditions are currently ample but show early signs of tightening due to potential reserve requirement changes.
- 03Geopolitical factors could still introduce volatility, impacting inflation and ECB policy.
- 04Market projections for EUR/USD highlight disparities, with some firms forecasting more dovish outcomes.
Market implications
Institutional traders should watch key levels around 1.1500 which could trigger shifts in positioning based on ECB signals. With no high-impact events scheduled on the calendar in the next 30 days, any market movement will largely depend on geopolitical developments and ECB communications.
Risks to this view
A substantial shift in energy prices or a sudden escalation of geopolitical tensions could invalidate the current bullish call, forcing a reassessment of the ECB's policy trajectory and potentially leading to a drop in the EUR/USD exchange rate.
EUR/USD — All Desk Targets
| Firm | Stance | YE 2026 |
|---|---|---|
Goldman Sachs | — | 1.2000 |
Commerzbank | — | 1.2200 |
UOB | — | 1.1445 |
Articles EUR Money Markets: Some signs of tightening conditions 14:51 Rates Share X LinkedIn E-mail Copy link Share X LinkedIn E-mail Copy link Download Easing energy prices have taken a July European Central Bank rate hike off the table, but September remains in play. Liquidity still looks ample, but there are some signs of increasing tightness. A doubling of the reserve requirement as mulled by the ECB risks an uneven tightening impact Benjamin Schroeder ECB policy outlook: Easing back from the energy shock The 60-day ceasefire in the Middle East has seen oil prices drop close to pre-war levels.
This has clearly eased inflation concerns, not just in the market but also among central bank officials. ECB officials have been cautious not to sound too dovish, however. Clearly, a hike in July has become unlikely, but the idea of further policy tightening down the road has been kept alive.
For one, there are clear risks around the deal in the Middle East and a re-escalation with another spike in energy prices remains a possibility. Secondly, the ECB will still want to monitor how the energy situation percolates through the economy before committing to any path. Markets have already made up their minds.
A hike in July is off the table, while September looks to be a coin toss. If anything, we think the ECB will act before the end of the year, and looking further along the curve, the market is just shy of fully discounting another hike from the ECB. We think the market can maintain its dovish bias for front-end rates if, on average, energy prices stay at benign levels and inflation does not surprise to the upside due to second-round effects.
But it will be a slow process, as such risks will be priced out over time as data materialises and ECB officials gradually shift to a more balanced tone. But for now, our economists are keeping a second rate hike in play. Liquidity and funding conditions: Still ample, but some signs of tightening conditions Excess liquidity in the banking system continues to contract as the ECB rolls off its bond holdings.
The current level of €2.2tr still appears ample, and that view is corroborated by the still very muted uptake in the ECB's regular liquidity providing operations. Banks are picking up €12bn in the weekly operation and another €13bn via the three 3m longer-term operations. Banks' pick up of liquidity from the ECB is rising only slowly Source: ECB, ING "> Source: ECB, ING That said, there are also signs that funding conditions are gradually turning tighter, especially around quarter-ends.
For instance, banks had picked up a slightly higher €18bn in the weekly operation, and we had seen somewhat higher recourse to the marginal lending facility into the turn of the quarter – just below €1bn still, but an increase in volumes compared to previous turns. Excess reserves continue to trend lower, but the rise in ESTR as stalled Repo markets have seen a more pronounced increase in general collateral (GC) rates over the turn of the quarter. Overnight Repo fund GC rates for Germany rose 3.5bp above prior levels and by more than 5bp for Italy, although the broader GC pooling basket only saw a relatively muted uptick.
Sources & References
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