4 possible hawkish surprises from today’s ECB Meeting

The big day for euro traders has arrived, as the European Central Bank (ECB) will deliver its monetary policy statement a few hours from now. Also, the press conference is of crucial importance because it will offer more details about the ECB’s plan to tighten financial conditions.

Without overstating, this could be the most important ECB meeting of the last 11 years. This is how long has passed since the ECB delivered its last rate hike, and now that it is preparing to tighten financial conditions, everyone with interest in financial markets wonders what is the road the ECB is taking?

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Compared to other central banks, the ECB faces a tougher decision. For others, it is all about fighting inflation.

But for ECB is inflation and the secondary effects of the war in Ukraine. Hence, by hiking the rates, the central bank may end up hurting the already hurt European economies. However, at the same time, inflation is off the charts, running at record-highs for Europe.

So what will the central bank do? Here are 4 possible hawkish surprises the ECB might deliver today:

• A rate hike today
• Commitment to 25bp rate hikes down the road
• Commitment to reaching neutral policy
• The risk of quantitative tightening down the road

25bp rate hike today

Most ECB watchers rule out a 25bp rate hike today. This is the consensus.

But the ECB was not shy in stating that ECB watchers are not the ones setting the monetary policy. In fact, in one of the press conferences held a while ago, Christine Lagarde, the ECB’s President, stated just that.

Hence, one could not rule out a rate hike today, even though the chances for it are slim. And even if the ECB hikes today, the EUR/USD exchange rate will have a hard time sustaining a rally for at least two reasons.

One is that the German/Italy spread rises with more expectations of an ECB rate hike. This puts pressure on the EUR/USD and makes the long EUR/USD trade difficult.

Another is the Federal Reserve. Next week, the Federal Reserve of the United States is set to raise the funds rate by 50bp – literally offsetting a possible 25bp from the ECB today and some more.

Because an exchange rate reflects the value of one currency in terms of another, traders should always consider factors from both central banks and economies as critical.  

Commitment of 25bp rate hikes down the road

As mentioned earlier, the ECB may not hike today – this is the consensus. But in doing so it will likely signal a 50bp rate hike in July – this is also more or less priced in.

The hawkish surprise, in this case, may come from a commitment from the central bank to deliver 25bp rate hikes once reaching positive territory.

Commitment to reaching neutral policy

The neutral interest rate is estimated at between 1%-2%, and if the ECB commits to moving rates at or beyond the neutral level after the tightening cycle begins, that would be a hawkish development for the common currency.

The risk of QT down the road

The ECB expanded its balance sheet dramatically during the last crises. As a result of this crisis, the balance sheet rose as one of the largest in the world, at least compared to its size as a percentage of GDP.

But now, the Fed in the United States has begun QT – the process of reducing the balance sheet, known as quantitative tightening. Any hint from the ECB that QT is possible sometime down the road should be a game-changer for the euro.