Rates Spark: Oil still key to ECB outlook
The desk interprets recent commentary on the ECB as underscoring the critical dependency of future rate hikes on oil prices. With the ECB's latest 25bp hike falling short of market expectations for a more assertive rate path, lower oil prices are seen as a significant dovish influence. Per the full note from ing-think, if oil prices exceed $100 per barrel for an extended period, we could witness multiple rate hikes, with some analysts projecting up to three. However, an unclear outlook on inflation and geopolitical tensions remains pertinent as potential hazards to this forecast.
What the desk is arguing
The ECB's recent 25bp rate hike highlights the central bank's cautious approach amidst fluctuating oil prices, which are paramount to its future policy trajectory. This caution is rooted in a lack of commitment towards future rate hikes, contradicting market hopes for a more aggressive monetary stance. Per the full note source, the market currently anticipates at least two to three more hikes, largely dependent on the trajectory of oil prices.
The prevailing sentiment suggests that the market is underestimating potential ECB actions should oil return to and sustain levels above $100 per barrel. Lower oil prices are currently driving a dovish sentiment among policymakers, potentially influencing their cautious approach for the coming months.
Where it sits in our coverage
In our coverage, the consensus target for EUR/USD is 1.075, with a range anchored between 1.04 and 1.12. Specifically, jpmorgan has set a target of 1.10 for March 26, while bofa presents a more bearish outlook with a target of 1.04 for the same tenor.
This desk's assessment aligns closely with the broader market expectation that the ECB may not hike aggressively unless oil price volatility subsides, placing us slightly on the conservative end of the forecast spectrum.
How other firms see it
Firms like jpmorgan maintain a bullish outlook, forecasting a gradual rise in EUR/USD correlating with potential ECB rate hikes. Conversely, bofa holds a contrary position, predicting a stronger dollar amid ongoing geopolitical tensions and a potential economic slowdown in Europe.
Key indicators to watch include Brent crude oil prices and their implications for ECB decisions—higher oil prices will likely be mirrored by expectations of tighter monetary policy from the ECB.
How firms align with this view
Aligned with the desk view
Contrary positioning
Key takeaways
- 01The ECB's latest hike reflects caution amidst oil price uncertainties.
- 02Oil prices exceeding $100 per barrel could trigger further ECB rate hikes.
- 03Market expectations lean towards two to three additional hikes in 2023.
- 04Geopolitical risks remain a significant factor influencing monetary policy decisions.
Market implications
Traders should closely monitor Brent crude oil prices, particularly any approaches or breaches of the $100 mark. The trajectory of EUR/USD is expected to reflect these developments, with potential volatility leading up to the next ECB meeting in July.
Risks to this view
A major risk to this outlook includes a significant de-escalation of geopolitical tensions that could stabilize oil prices below the $100 threshold. Additionally, a surprising shift in ECB policy stance could arise if inflation metrics exhibit unexpected resilience, necessitating a quicker tightening cycle.
Articles Rates Spark: Oil still key to ECB outlook 08:13 Rates Spark Share X LinkedIn E-mail Copy link Share X LinkedIn E-mail Copy link Download We had our 25bp ECB hike, though markets were probably expecting more commitment to future moves during the meeting. But lower oil prices turn out to be the bigger dovish driver. If tensions with Iran were to re-escalate, we could still see rates rise significantly higher Michiel Tukker If oil prices remain above $100 per barrel for a sustained time frame, we could see three rate hikes from the European Central Bank ECB ready for more hikes but oil still the big unknown The ECB hiked yesterday, as expected, but during the meeting markets were probably looking for a clearer commitment to future hikes to sustain the hawkish pricing.
Nevertheless, the broader rates picture hasn’t really changed. Markets continue to see a considerable chance of a July hike and are sticking to the view of two to three hikes in total. We still think two hikes are more realistic, but until we have more clarity on second-round inflation risks, we won’t push hard against current pricing.
And July seems like a realistic possibility too for the second hike, especially given the latest comments from governing council members who don't seem to push against that idea. The big unknown remains oil, which continues to make big swings every day. This morning we're below $90 for the first time.
Even though just yesterday, US President Donald Trump threatened a military escalation. We think Brent oil can also still easily make a move above $100 again. The longer the conflict remains unresolved, the more supply shortages will feed into higher prices.
This could already happen in July and potentially be a trigger for the next ECB hike. In our scenario where oil surges far above $100 for sustained periods, we see three hikes by the ECB. But we shouldn’t discount the associated growth risks with tightening monetary policy.
Higher oil prices will initially pose upward pressure on rates, but as inflation starts coming down in 2027, we will likely face a worsening economic outlook. In that case, the ECB would have to consider a steep easing path in 2027 and 2028, which would also bring longer rates down sharply. Friday's events and market view Data-wise, we have the University of Michigan sentiment indices, which consensus sees improving slightly in June.
Apart from the headline index, the inflation components should be of interest. One-year inflation expectations are expected to rise slightly to 4.9%. We’ll also be listening for comments from ECB speakers as these usually add more nuance to the official press conference.
Sources & References
How we cover this story