Markets are pricing in no rate hike from the ECB at the end of its policy meeting on Thursday. But there is some key data coming out just hours before the decision is released that could shake up expectations. On top of that, traders are growing impatient for signs that the ECB will act on rising inflation. All that combines to imply the potential for significant Euro volatility around the rate decision.
At the last meeting, the ECB essentially kept a holding pattern to see what would happen in the Middle East. The issue is that the main uncertainty remains unresolved. The closure of the Strait of Hormuz is raising energy costs and pushing up inflation expectations, while dragging on the European economy. It could open at any moment, which makes policy decisions for the ECB particularly hard. The question is whether members will opt to wait until the subsequent meeting (which isn’t until June) or start hinting that rate hikes are coming to tame already-rising inflation.
The Data Outlook
While ECB officials are debating what to do with rates, Eurostat will simultaneously release two key data points that could shake up market expectations. Flash Eurozone CPI is expected to accelerate to 2.9% from 2.6%, moving further away from the ECB’s 2.0% target. Meanwhile, core inflation is expected to remain steady at 2.3%, implying that the effects of the war on consumer prices may still be largely transitory if the Strait is opened immediately.
The other data point is Flash Eurozone Q1 GDP, which is expected to stay unchanged at 0.2%. The annual growth rate is anticipated to cool to 0.9% from 1.2%. This puts the shared economy dangerously close to stagflation, and complicates the ECB’s response to higher inflation. If it hikes rates aggressively to get consumer prices back in line, it risks killing the meagre economic growth in the region or even precipitating a recession.
What Are the Odds for a Hike
The market is fully pricing in two rate hikes by the end of this year, with the first in the summer. This is particularly relevant because the next meeting after Thursday is in June. If the ECB gives a hawkish signal, the market could move to pricing in a rate hike for the next meeting. This could boost the Euro, at least initially.
On the other hand, June is quite far away, and the ECB might be reluctant to allow inflation expectations to build for three months (counting from the start of the war) before taking action. This could provide a delicate rhetorical balance for ECB President Christine Lagarde during her post-rate-decision press conference. She’ll have to suggest that rates will rise, but also leave enough room to allow for adjustment if the Strait is reopened over the next six weeks.
Uncertain Market Reaction
Markets are already anticipating ECB hawkishness, which means there is a greater chance of a dovish surprise. However, the moves in the currency could be short-lived as the market takes time to digest the implications.
A more dovish ECB implies a weaker Euro, but that would also help support the economy and make the currency more attractive. This could mean the downside fades fairly quickly. The verse in the case of a hawkish surprise, as the initial reaction to the prospect of higher rates could elevate the Euro, but then retrace as investors see a slower economy.
