The Euro has generally appreciated over the last week as traders become more convinced that the next move from the ECB will be a hike. The question is whether that will be signaled at the upcoming meeting. Markets and economists are unanimous in expecting the ECB to hold for the fourth time in a row at the upcoming meeting on Thursday. Given the strong expectations around the meeting, the chances of a market reaction will likely rely on a change in the central bank’s rhetoric.
There is a disagreement in the outlook between economists and the market. According to the latest survey of economists conducted by Reuters, there is unanimity in expecting the ECB to keep rates unchanged all the way until the end of next year. By contrast, over the last week, markets have gone to pricing in a rate hike around October of 2026. This means the ECB outlook has shifted to a hawkish bias.
Why Is the ECB Expected to Be More Hawkish?
After a couple of years of inflation being well above target, the ECB has finally got it back under control. But, since then, CPI has been just slightly above target. Compared to where it was in, say, 2022, inflation is now in a “good place”. But, the central bank tolerates a little deviation from the target, understanding that it will be in both directions. If inflation persists above target and doesn’t dip below for a little while to compensate, then the central bank might have to do something.
This seems to be the thinking of an increasing number of analysts and even a few members of the ECB itself. Germany’s MPC member Isabel Schnable earlier this month said she was comfortable with predictions that the ECB would hike next. This set off the debate that rather than the next move being a cut amid a sluggish economy, the shared central bank might have to raise rates.
What Will the ECB Do About Inflation?
Hiking is the main tool that the central bank has to address rising inflation. But it also has economic impact, and higher rates can weigh on the economy. The ECB might not want to smother the slow growth that the Eurozone is experiencing. However, the economy is expected to pick up a bit next year, which could add further upward pressure to inflation. And the latest trend has been for inflation to rise.
An alternative is to use rhetoric to try to bring the inflation rate down by a couple of decimals and back in line. This is known as “jawboning” and is a common practice among central bankers. The idea is that President Christine Lagarde might take on a more hawkish tone after the upcoming meeting in an attempt to head off rising inflation.
What to Look Out For
The recent rise in the EURUSD might be attributed to hopes that the ECB’s rhetoric will be more hawkish. Which means that the market could react negatively if the ECB sticks to its prior statement. In the past, Lagarde has repeated the phrase that inflation and interest rates are “in a good place”. If she doesn’t express concern about inflation, then markets could perceive the ECB as more dovish.
On the other hand, if Lagarde drops the phrase or couches it in terms of concern about consumer prices, the market might assume the ECB has adopted a hawkish bias. If the market shifts to waiting for signs of when a hike will occur, that could help support the EURUSD into the end of the year.
