ING Preview: Council Divisions to Dominate, Short-Lived Euro Gains on ECB Rate Hike
According to ING, there will be a sharp Euro reaction to Thursday’s ECB policy decision, especially with markets split on whether rates will be increased again.
It adds; “September’s ECB meeting will be a binary risk event for the euro. Our baseline scenario sees a rate hike, which would translate into a stronger euro in the aftermath of the announcement, as market pricing is leaning in favour of a hold.”
It expects 1.07 for the Euro to Dollar (EUR/USD) exchange rate will hold ahead of the decision.
The bank, however, expects a short-lived impact with the attention quickly moving back to Federal Reserve expectations and dollar moves.
Market pricing has also shifted with close to a 70% chance of a rate hike following reports on Wednesday that inflation forecasts will be increased.
This shift in pricing will limit the scope for Euro gains if rates are increased.
ING notes that the decision is a close call and, if the ECB decides against a rate hike, the Euro would dip in an immediate reaction.
Looking beyond the immediate reaction, ING still sees near-term downside Euro risks before a longer-term bullish trend develops. It adds; “We still expect a turn higher in the pair, but patience is the name of the game for EUR/USD bulls like us, and more downside corrections even after a potential ECB hawkish surprise are a very tangible risk.”
According to ING, one important element is that the Governing Council is likely to be more fragmented than usual.
It notes; “Whichever direction the ECB decides to take, the debate will likely be fiercer than in previous meetings, as lingering core inflationary pressure is being counterbalanced by evidence of rapidly worsening economic conditions in the euro area.”
Overall, ING considers that the most likely outcome is that the ECB will decide on a further rate hike of 25 basis points to 4.50% for the refi rate, especially as real interest rates have declined.
Forward guidance will inevitably be important and the credibility of guidance will also be a key factor, especially given increased concerns over the Euro-Zone economy.
According to ING; “with economic conditions deteriorating fast in the eurozone and dovish dissent within the ECB growing, it will be hard to convince markets to price in any additional tightening.”
ING adds; “If it can, then you have a trampoline for a sustainable EUR/USD rebound, otherwise – and we really think this will be the case – the best President Lagarde can do for the euro is to offer a lifeline.”
ING notes that the policy on the selling of bonds into the market will also be potentially important.
It could increase the amount of bonds being sold which would underpin the Euro.
Given the risks that peripheral bond yields could increase, however, ING expects that it will be very cautious over such a move.