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Breaking News: ECB Hikes by 75 Bps, Citing Inflation Risks, EURUSD Down

Breaking News: ECB Hikes by 75 Bps, Citing Inflation Risks, EURUSD Down

Richard Snow, Analyst

ECB Rate Decision

  • ECB hikes by 75 basis points, stressing that inflation is too high and expected to remain high for an extended period. Further hikes to come
  • Maturing PEPP and APP proceeds continue to be reinvested
  • Separate note on TLTRO to be provided at 15:45 CET
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ECB Hikes by 75 Bps in Line with the Forecast

  • The ECB decided to hike by 75 basis points as inflation remains too high and poses a risk of staying elevated for longer.
  • Asset purchases are to continue to be reinvested (APP and PEPP)
  • Further hikes expected but will remain dependent on data and economy
  • No mention of QT, TLTRO facility will see a change in the rate to counter bank arbitrage

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ECB Dilemma: Hike into Recession or Tolerate Higher Prices for Longer?

The eurozone, perhaps apart from the UK, presents one of the toughest financial climates in recent history as it contends with the negative effects of the war in Ukraine which has resulted in an energy crisis, as well as having to hike interest rates rather aggressively in order to tame rampant inflation. However, tightening monetary conditions can lead to dislocations, as we saw in the UK bond market although there was a political element to it, and the ECB is hoping to avoid surging bond yields in the PIGS countries (Portugal, Italy, Greece and Spain) via its existing tools alongside the recently introduced Transmission Protection instrument (TPI). It remains a delicate balancing act.

Relatively Hawkish ECB Hike Highlight’s How Far the ECB Still has to go

The decision by the Governing Council to hike by 75 bps goes against the slower pace of rate hikes we have seen from the Reserve Bank of Australia, and the Bank of Canada as recently as yesterday. The respective 25 bps and 50 bps hikes signal that central banks may soon be reaching what they believe to be the terminal rate in upcoming rate meetings.

Trajectory of Major Central Bank Policy Rates (BoC and RBA flattening)

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Source: Refinitiv, prepared by Richard Snow

In addition, comments by the Fed’s Mary Daly concerning risks of possible overtightening and the inevitable step down from 75 bps hikes to 50 or 25 in future, produced a double top in the dollar index (DXY) that sees the index trade around 3.5% lower. Similar declines in the US 2-year treasury and US 10-year yields of 4% and 8% respectively have helped USD counterparts to rally in recent days. Euro bond yields were lower ahead of the announcement with Italian yields down 50 bps from the September high, with German bund yields lower by around 35 basis points.

Considering the lackluster flash October PMI data, the 75 bps hike shows the council’s determination to lower inflation even if it’s at the cost of slower economic growth. Yesterday, German and EU manufacturing data significantly missed forecasts – underscoring the economic fragility of Europe as the continent heads into the colder winter months.

Flash German and Euro Area PMI data (October)

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Source: DFX, prepared by Richard Snow

Immediate Market Response: EUR/USD 'Sells the Fact' After ECB Rate Hike

The 75 basis point hike has been much talked about by ECB officials and was largely priced in ahead of the hike. EUR/USD had also rallied higher on the 'Fed pause' narrative after Mary Daly stressed the risk of overtightening and the probability of slower rate hikes going forward. The Wall street Journal also published an article stating that next week's FOMC meeting is to hold discussions on how future slower hikes are to be communicated.

As a result, its not surprising that the EURUSD pair has sold off by as much as 50 pips after the release in what looks like a 'buy the rumor sell the fact' response to the anticipated 75 bps hike. On the day, the pair has traded between parity and 1.0100 - two key levels if the euro is going to show any sign of a longer term bullish reversal.

EUR/USD 5-minute chart

Source: Tradingview, prepared by Richard Snow

--- Written by Richard Snow for DailyFX.com

Contact and follow Richard on Twitter: @RichardSnowFX

DailyFX provides forex news and technical analysis on the trends that influence the global currency markets.

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