Euro drops sharply as Lagarde says the ECB is not where the Fed is

Today’s European Central Bank (ECB) meeting was long-awaited by euro traders looking for clues as to where the monetary policy in the euro area will go next. The ECB faces a tough choice, and it is in a difficult position.

On the one hand, inflation is well above the central bank’s target. Yet, the interest rate on the deposit facility is in negative territory.

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Therefore, the ECB should normalize the policy to cool inflation.

But the war in Ukraine is a game-changer for the European economies and for the ECB. The central bank now fears that the negative impact will be exacerbated if the ECB begins normalizing the policy under such conditions.

Everything that the ECB’s President, Christine Lagarde, said at the press conference was negative for the euro. In particular, the reference that the ECB is not where the Fed is in terms of monetary policy. As such, the divergence between the two central banks’ policies is expected to continue, and so the EUR/USD exchange rate dropped to a new 2022 low.

What did the ECB decide?

One of the most important decisions today was the announcement that the central bank plans to end net asset purchases in the third quarter of this year. Normally, such an announcement should be a hawkish statement.

However, the ECB fell short of a firm commitment to end the program in June, and so a rate hike in July seems to be off the table.

Why did the common currency drop?

The euro dropped across the board, with the EUR/USD leading the way. But it was not the only currency pair to decline – EUR/GBP dropped too, for example.

Traders did not like the fact that the ECB is not ready to tighten the policy. Moreover, it has no schedule for reducing its balance sheet like the Fed in the United States has.

Where will the EUR/USD exchange rate move next?

The EUR/USD made a new low for the year as part of a bearish trend that started in 2021. Given the divergence between the two central banks, the EUR/USD exchange rate should remain bearish with 1.03 or lower levels possible, as the Fed signals a 50bp rate hike at its May 2022 meeting.