Market Wire - ECB Front-Loads Hikes, Euro Jumps

The European Central Bank delivered its first rate hike in 11 years, raising all three benchmark rates by an outsized 50 basis points, and hinted strongly that it would follow up with further increases in September. The move was more aggressive than forecast by most economists, but as with the Fed last month, a pre-meeting press leak had nudged markets at least partly in that direction.

The euro rallied immediately after the decision was released.

The accompanying statement said, “At the Governing Council’s upcoming meetings, further normalisation of interest rates will be appropriate. The frontloading today of the exit from negative interest rates allows the Governing Council to make a transition to a meeting-by-meeting approach to interest rate decisions”. 

Policymakers acknowledged broadening price pressures and the risk that expectations could be contaminated by large and persistent overshoots in headline inflation, suggesting that an aggressive tightening in policy would help in “strengthening the anchoring of inflation expectations and by ensuring that demand conditions adjust”. 

The statement announced the approval of a Transmission Protection Instrument to counter a widening in intra-euro area spreads, but did not give much detail about the proposed tool. Additional implementation information will be provided just before the post-announcement press conference in 15 minutes. It is also unclear whether policymakers will extend the program to Italy in its current political state, as it is intended only to fight “unwarranted” or “unjustified” spread-widening.  Internecine combat that topples a national unity government - even one headed by the most celebrated ex-president of the ECB - may not make the cut.

Sentiment on the euro is driven by at least three separate things—benchmark interest rates, peripheral political risk, and the growing risk of an energy-supply induced recession. This hike might help lift the exchange rate, but a more lasting bounce depends on other factors the central bank does not control.