The European Central bank (ECB) raised the interest rates by 75bp at yesterday’s monetary policy meeting and said there will be more rate hikes to fight inflation. That was in line with our expectations.
The European policymakers revised their inflation expectations significantly higher and slashed their growth expectations significantly lower, but… said that they do not expect a recession in Europe. They apparently don’t want to take the possibility of a mild winter off the table.
Jonathan Ferro on Bloomberg called it laughable. But it’s maybe just a cover story.
Indeed, raising the rates into a slowing economy, combined with food and energy crisis looming on the continent, and without even talking about how the strong US dollar overcomplicates things, it will be hard to avoid recession in Europe.
BUT what’s more reasonable – and is certainly untold – is, that the ECB is frontloading the jumbo rate hikes to keep the euro strong enough to, at least, fight the negative impacts of the strong dollar. And telling the world that they expect a recession doesn’t work for keeping the expectations hawkish.
Anyway, the euro fell while Christine Lagarde spoke, but could rebound and stay above parity against the US dollar during the overnight trading session.
And now that the ECB doesn’t expect recession in Europe, they should continue hiking the rates by relatively big chunks in the next few meetings. Money markets already price in about 40% chance for another 75bp hike in October. ECB officials will also start talking about shrinking the size of the balance sheet when they meet in Cyprus at the beginning of October, which is a non-policy meeting.
All in all, there are a few elements that sound hawkish for the ECB. If the reality allows the ECB to tighten its purse’s strings, they will do it.
Does it mean that the euro could appreciate against the dollar? Nobody knows that. It depends on how strong the US dollar could become.
But what we know is that, even Japan said it won’t rule out options if the excessive FX moves continue. They also think that the fundamentals don’t explain an almost 30% ytd appreciation in the USD against the yen!
The USD strength is no longer sustainable, indeed. But inflation in the US remains high, the US labour market is relatively strong – even too strong, the medium-term outlook for the US economy is much better when compared to Europe or the UK, and the periods of global crisis normally benefits to the greenback.
Still, Bill Gross is betting on pound sterling, because he thinks that the US dollar is exaggeratedly overvalued against other major currencies, and that there should be a correction in the foreseeable future, despite all the factors I enumerated above. Cable is testing the 1.16 mark this morning. But the Brits have other things on their mind today, than their crumbling currency. Queen Elizabeth II closed her eyes yesterday. Charles could finally take the reins.
Euro Stoxx first fell than recovered to close the session slightly in the positive, the bank stocks jumped more than 2% as the higher rates will increase the risk-free income for the banks and boost their interest revenues.
The US indices also had a positive session, although the Federal Reserve (Fed) Chair Jerome Powell hinted that the jumbo rate hikes will continue to tame inflation in the US, as well. The S&P500 closed the 4000 mark, while Nasdaq added 0.50%. Futures hint at positive start at the time of writing.
