The European Central Bank (ECB) is expected to raise the interest rate on the Main Refinancing Operations and the Deposit Facility by 25 basis points (bps) to 2.65% and 2.50%, respectively. The ECB will announce the decision on Thursday at 12:15 GMT.
Unlike in July, the interest rate decision will be accompanied by the central bank staff’s updated economic projections and followed by ECB President Christine Lagarde’s press conference at 12:45 GMT.
The Euro (EUR) is likely to experience intense volatility around the ECB’s policy announcements, as all eyes will be on the central bank’s signals on the future rate path.
What to expect from the ECB interest rate decision?
The ECB is set to resume raising interest rates after pausing at its July monetary policy meeting.
Renewed hostilities in the Middle East and the resulting rebound in energy prices continue to spur inflation concerns and bolster rate-hike expectations.
The Eurozone’s Harmonized Index of Consumer Prices (HICP) annual inflation accelerated to a nearly three-year high of 3.3% in August, remaining above the ECB’s 2% target.
Meanwhile, the Q2 Gross Domestic Product (GDP) in the Old Continent grew 0.6% quarter-on-quarter (QoQ) after contracting by 0.2% in the first quarter. On a yearly basis, economic growth rose 1.2% from 0.3% in the preceding period.
“The Eurozone macro backdrop argues in favor of bringing the policy rate closer to the upper end of the ECB’s 1.75%-3.00% neutral range. The swaps curve more than fully prices in ECB rates at 3.00% in the next twelve months, which is EUR supportive,” Analysts at BBH explained.
With a rate hike on Thursday all but certain and little change expected to September’s inflation and growth forecasts, the main focus will be on the language in the Monetary Policy Statement and President Lagarde’s comments during the post-policy meeting press conference.
Given recent hawkish commentary from several ECB policymakers, markets will closely watch for any hints from Lagarde about the possibility of additional rate hikes this year.
How could the ECB meeting impact EUR/USD?
The Euro remains stuck in a narrow range below 1.1650 against the US Dollar (USD), consolidating the pullback from three-month highs of 1.1711, ahead of the ECB event risks.
If President Lagarde signals that additional tightening could be needed, particularly because inflation remains well above the 2% target, markets could price a higher terminal rate.
A hawkish tone, combined with upward revisions to inflation forecasts, would likely support the Euro and push EUR/USD back above the 1.1700 round level.
On the other hand, the Euro could weaken sharply and send EUR/USD toward 1.1550 if the ECB president emphasizes weaker growth risks and characterizes the inflation shock from energy prices as temporary, suggesting a more cautious approach to future tightening. This scenario could prompt traders to scale back expectations for additional rate hikes and weigh on the EUR.
Dhwani Mehta, Asian Session Lead Analyst at FXStreet, highlights key technical levels for trading EUR/USD following the monetary policy announcement.
“The pair trades above the 21-day, 50-day and 100-day Simple Moving Averages (SMAs), while battling the 200-day SMA around 1.1640. The cluster of underlying SMAs suggests a constructive backdrop, and the Relative Strength Index (RSI) around 58.50 on the daily chart hints at firm but not overextended bullish momentum.”
“On the topside, the first hurdle aligns at the 1.1700 threshold. A sustained break above this barrier would open the way for a retest of the 1.1750 psychological barrier. Above that level, the 1.1790 supply zone will be exposed. On the downside, initial support is seen at the 100-day SMA around 1.1560, and the 50-day SMA near 1.1526, providing deeper layers of demand should a pullback unfold.”
Euro supported as ECB pricing leans toward hawkish path
Strategists at Scotiabank noted on Wednesday that market expectations remain firmly aligned with further ECB tightening, with “a 25bpt rate hike…fully expected at Thursday’s meeting, and another 25bpts…priced in for December.” They add that they “anticipate a hawkish hike tomorrow,” as President Lagarde presents the updated projections and “unveils the latest forecast and signals ongoing concern about upside risk,” reinforcing the Euro’s policy-supportive backdrop.
Central banks FAQs
Central Banks have a key mandate which is making sure that there is price stability in a country or region. Economies are constantly facing inflation or deflation when prices for certain goods and services are fluctuating. Constant rising prices for the same goods means inflation, constant lowered prices for the same goods means deflation. It is the task of the central bank to keep the demand in line by tweaking its policy rate. For the biggest central banks like the US Federal Reserve (Fed), the European Central Bank (ECB) or the Bank of England (BoE), the mandate is to keep inflation close to 2%.
A central bank has one important tool at its disposal to get inflation higher or lower, and that is by tweaking its benchmark policy rate, commonly known as interest rate. On pre-communicated moments, the central bank will issue a statement with its policy rate and provide additional reasoning on why it is either remaining or changing (cutting or hiking) it. Local banks will adjust their savings and lending rates accordingly, which in turn will make it either harder or easier for people to earn on their savings or for companies to take out loans and make investments in their businesses. When the central bank hikes interest rates substantially, this is called monetary tightening. When it is cutting its benchmark rate, it is called monetary easing.
A central bank is often politically independent. Members of the central bank policy board are passing through a series of panels and hearings before being appointed to a policy board seat. Each member in that board often has a certain conviction on how the central bank should control inflation and the subsequent monetary policy. Members that want a very loose monetary policy, with low rates and cheap lending, to boost the economy substantially while being content to see inflation slightly above 2%, are called ‘doves’. Members that rather want to see higher rates to reward savings and want to keep a lit on inflation at all time are called ‘hawks’ and will not rest until inflation is at or just below 2%.
Normally, there is a chairman or president who leads each meeting, needs to create a consensus between the hawks or doves and has his or her final say when it would come down to a vote split to avoid a 50-50 tie on whether the current policy should be adjusted. The chairman will deliver speeches which often can be followed live, where the current monetary stance and outlook is being communicated. A central bank will try to push forward its monetary policy without triggering violent swings in rates, equities, or its currency. All members of the central bank will channel their stance toward the markets in advance of a policy meeting event. A few days before a policy meeting takes place until the new policy has been communicated, members are forbidden to talk publicly. This is called the blackout period.
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