The market was greeted with an unexpected shock yesterday after the European Central Bank (ECB) hiked its interest rate by 50 basis points (bps). This was contrary to the market expectation of just 25 bps. This has brought the interest rate for Euro down to zero from the previous record of minus 0.50%. The primary refinancing rate has decreased to 0.5%, while the current marginal lending rate is now 0.75%. The last time the interest rate for the Euro was raised was 11 years ago, in 2011, precisely during the economic crisis.
The ECB indicated that it would raise interest rates in July and September because of the rising inflation. Investors have been more dovish inclined toward the procedures for executing this process. Hence, this explains the cause of the shock witnessed yesterday when the committee kickstarted the interest rate hike aggressively yesterday, all in the bid to fight the rising inflation. Judging from the inflation report for June released last week, it was discovered that the inflation rate rose to a 22-year high at 8.6% YoY against the 8.1% recorded in May.
To this end, during their session yesterday, the committee considered it necessary to embark on an aggressive interest rate hike for the Euro. Following the committee's report on Thursday, the Governing Council deemed it necessary to take a more significant step on its first move toward policy rate normalisation. It was forced to proceed with 50 bps hiking contrary to the 25 bps signal earlier during the previous meetings.
Analysts further expect the ECB to hike its interest rate by 50 bps in September and next by 25 bps subsequently until the inflation rate returns to the committee target of 2.0%. This had to be inferred from the position of the committee to consider further hiking if the inflation persists.
The monetary policy committee (ECB) stated yesterday that their target for the initiated interest rate hike was to bring inflation down to 2.0%. They reported that the committee will support the return of inflation to the Governing Council's medium-term target of 2.0%. "By strengthening the anchoring of inflation expectations and ensuring that the demand conditions adjust to deliver its inflation target in the medium term."
The ECB president - Christine Lagarde - confirmed that the committee was forced to take an aggressive initial interest rate hike due to the rising inflation rate. In her words: "Inflation continues to be undesirably high and is expected to remain above our target for some time." Additionally, she reported that "the latest data on the inflation report for last month indicated a slowdown in economic growth, clouding the outlook for the second half of 2022 and beyond."
The major challenge for the ECB is how to help those EU countries with high debt records, especially Italy, to come out of stagnation and recession if a further rate hike is executed. To assist these countries, the ECB developed the 'anti-fragmentation tool' designed to support those nations with a high record of debts in gradually paying back their debts. This tool is to be activated to counteract the unwarranted, disorderly market dynamics that seriously threaten monetary policy transmission across the euro area. The anti-fragmentation tool is a transition protection instrument that would assist riskier European countries in repaying their debts without borrowing more. According to the committee, the remedy would be that they stick to "sound and sustainable fiscal and macro-economic policies."
What effects is the recent interest rate hike expected to have on EURUSD
Historically, hiking the interest rate for a particular currency always boosted the country's currency. This is because interest rate hikes help reduce the amount of money in circulation, thereby creating a natural scarcity for the currency, strengthening its exchange value in the long term. Hence, the recent interest rate hike for the Euro is expected to initiate a sustainable track for the Euro recovery over time, especially with the prospect of further rate hiking in September.
As expected, the market had initially reacted positively to this news yesterday when the bulls pushed EURUSD to a new high at $1.0275 before a short retracement ensued. However, more uptrend movement will be anticipated for the Euro in the coming weeks.
Currently, the primary target for EURUSD is $1.0308. A break above it will lead us to higher levels at $1.0384. Alternatively, should the price fail to hold at the current level, we might expect a retest of the support at $1.018 or $1.008.
The general sentiment towards EURUSD presently is bullish.