ECB meeting preview: rates expected to rise, but slow pace could put pressure on EUR/USD

ECB meeting: the basics

The forthcoming European Central Bank (ECB) meeting will take place on Thursday 21 July 2022. The initial monetary policy decision will be announced at 1.15pm BST, with the press conference getting underway at 1.45pm.

What are the current issues faced by the ECB?

Much like their Western counterparts around the world, the ECB are faced with a historic rise in inflationary pressures. Despite knowing the importance of economic growth and prosperity, inflation is typically the number one issue that a central bank must keep on top of in a bid to avoid earnings erosion or a stagnating economy. However, a plethora of factors including Russia-Europe energy flows, and post-Covid-19 price hikes have brought about a rapid surge in inflation. The chart below provides both an idea of the scale of this move, but also the consumer price index (CPI) differential between Western and Asian nations.

That gap can be explained in a number of ways, but it is certainly notable that while Japan has typically struggled with inflation, Chinese energy pressures have been notably less problematic as they have taken much of the excess Russian output rejected by Europe. Cheap and plentiful energy does dampen inflationary pressures in the country, while Europe struggles to shift away from Russian energy just as other inflationary pressures take hold.

Interestingly, we can see how inflation expectations across both the US and eurozone have eased somewhat over the course of the past month. Comparing that chart with commodity prices, we can see the dollar driven decline in commodity prices has helped lessen inflation expectations over the past month. While this does take some of the heat off the ECB, they still have to deal with the fact that headline CPI currently stands at 8.6%.

From an economic perspective, we have recently seen weakness across the likes of retail sales, composite purchasing managers index (PMI) surveys, gross domestic product (GDP), and consumer confidence all taking a hit over as this crisis plays out. There is clearly a need to address inflation, but the ECB will also want to be cautious to avoid a sharp recession where possible.

What to expect from the ECB

Unlike their peers, the ECB has been very slow to act despite the unfolding economic crisis. Rocketing inflation rates have done little to move Christine Lagarde & co, with the bank’s indecision helping to drive the euro lower against most other currencies. The chart below highlights how the ECB’s hesitance stands in stark contrast to their counterparts in the UK, Canada, Australia, and the US.

Despite this growing disparity in rates, markets are pricing in a mere 30 basis point (bp) hike to the current deposit facility rate which lies at -0.50%. Given the fact that we are seeing other regions hike by up to 100 bp, the ECB certainly has the capacity to surprise should they wish to. Otherwise, markets are looking towards the September meeting to provide a ramp up in monetary tightening. As we can see below, markets are pricing in a 130-bp move over the course of the next three-meetings.

Another issue that remains to be resolved comes in relation to bond yields, with surging Italian yields providing a problem for Lagarde. With risks increasing, the fact that Italian yields are so extended does stifle their ability to respond to the current crisis. The plan is to provide a new anti-fragmentation backstop, which should help protect the value of the euro and benefit Southern European economies. While we are not expecting to see it implemented on Thursday, traders should keep an eye out for any clarification on how the policy would take shape. It is likely to take the shape of a OMT style policy that intervenes when relative bond spreads are deemed to have moved beyond a desired threshold.

EUR/USD pushing higher after parity breach

EUR/USD has started to regain lost ground following a break below parity for the first time since 2002. The daily chart highlights how we are seeing the tide change as momentum sings in favour of the bulls. The push out of oversold on the stochastic brings a more positive outlook, but the expected hesitancy from the ECB could bring another turn lower soon enough. This rally thus looks like a potential upward retracement, with any moves into Fibonacci or trendline resistance particularly looking like good shorting opportunities.

DAX rallies into trendline resistance

The DAX has enjoyed a welcome boost over recent trading days, with the price rising into the 13021 resistance level. A break through that level could see stocks regaining some lost ground. However, we are not out of the woods just yet, with both the intraday and wider trend highlighting the potential for a bearish turn before long.