A preview of the ECB monetary policy decision: what to expect?

By:
on Jan 31, 2023
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  • ECB is set to hike the key interest rates by another 50bp on Thursday
  • Inflation keep rising in Europe
  • ECB likely to be hawkish

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The European Central Bank (ECB) will announce its monetary policy decision on Thursday. It is the first time the ECB meets in 2023, and the market expects a 50bp rate hike.

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It will bring the main refinancing rate to 3% from the current 2.5%, and the ECB’s hawkishness is one of the reasons why the EUR/USD exchange rate bounced from the 2022 lows last October. The currency pair rose by more than 1,000 pips on a combination of ECB hawkishness and the Fed slowing down the pace of interest rate hikes.

Can the ECB surprise markets? It sure can.

The hawkish case

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The ECB is fighting high inflation and wants the markets to believe it will do anything to bring back price stability. Inflation appeared to have slowed down in Europe, but this week’s report from Spain showed that inflation rose by 5.8% YoY when the market expected 4.9% YoY.

Hence, the ECB will want to make sure that the market understands that it is far from over with the rate hikes.

The market has priced in a 50bp rate hike, but the nuances matter more than the actual hike. One hawkish outcome would be that the 50bp rate hike would be accompanied by fully committing to another 50bp rate hike in March.

Also, if the ECB announces that it plans to stop the PEPP reinvestments in 2023, that would represent another hawkish development.

The dovish case

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On the dovish side, the ECB may still hike 50bp and stay dovish. It may use the worsening economic outlook as an excuse for signaling a slower tightening pace.

Also, if it mentions that the APP reduction can be paused if necessary, then the common currency might be hurt.

All in all, it is a big week for the euro. The EUR/USD currently consolidates above 1.08, and buyers are likely to emerge on a move into the 1.07-1.06 area.

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