The ECB's Rate Hike: EUR/USD Rally in Question

EUR: A post-hike rally may not last

We published two previews of today’s ECB policy announcement. Here is one from our economics teams, explaining why we expect a 25bp rate hike; and here is our ECB cheat sheet, where we look at four potential outcomes along with implications for rates and FX.

Since we wrote those previews, markets have grown more confident that the ECB will go ahead with a hike today, especially after Reuters reported that the new staff projections will include an upward revision of 2024 inflation to above 3%. We were not expecting this meeting to be a turning point for EUR/USD. The recent hawkish repricing in EUR rates helped us consolidate this view, and even if we expect a EUR-positive hike today, we admit it is a close call, meaning the balance of risks is asymmetrically skewed to the downside for the euro.

The main reasons why we aren’t convinced the ECB can trigger a sustainable EUR/USD rally are current pricing and communication challenges. Markets are pricing in 23bp of tightening by year-end, so the effective beneficial effect of a hike today would depend on how much the statement and President Christine Lagarde’s press conference manage to convince markets that the door remains open to more tightening. The risks here are twofold: that the message fails to hide the doves’ discontent with a hike; or that the doves manage to dwarf data-dependency. There is also the additional possibility of some dissenter tipping the media after the announcement with some more dovish statement.

We think that the most bullish outcome for the euro, especially in terms of the sustainability of a euro rally beyond the very near term, would require a united front on data dependency and/or openness to an acceleration in quantitative tightening. Otherwise – and this is our base case – we expect a EUR/USD post-meeting jump to stall around 1.0800/1.0830 (if not falling short of those levels), and gradually giving up gains as the dollar’s momentum remains solid.