The intrigue surrounding the possible outcomes of the meeting will persist until the last minute: there is no consensus in the market on how much the Central Bank will raise interest rates. The fact of the increase is not up for debate, but the scale of monetary policy tightening and its further prospects are open questions.
The balance of opinion leans towards implementing a 25-point scenario. Specifically, 57 out of 69 economists surveyed by Reuters believe that the ECB will raise rates by 25 basis points at its May meeting. At the same time, 12 respondents predicted a 50-point rate increase.
Baseline scenario
Several fundamental factors support the “moderate” development path, considered a “baseline” scenario.
For instance, Eurostat published April data on inflation growth in the Eurozone countries yesterday. The release puzzled market participants with its contradictory results. The consumer price index has consistently decreased for five months (from November to March inclusive), reflecting a slowdown in overall inflation. However, in April, it showed an upward trend, rising to 7.0% (from the previous value of 6.9%). On the other hand, the core CPI, excluding energy and food prices, has slowed its growth for the first time in the past nine months, standing at 5.6% (after reaching an all-time high of 5.7% in March).
These ambiguous results puzzled the “hawks,” especially against the backdrop of declining inflation rates in Germany. The German consumer price index, expressed annually, fell in April to 7.2%, with a forecast decline to 7.3%. The annual Harmonized Index of Consumer Prices (HICP), which the ECB prefers to use for measuring inflation, came in at 7.6%, while most experts predicted a rise to 7.8%.
Another argument favoring implementing the 25-point scenario is the ECB’s quarterly review of bank lending, which pointed to a sharp drop in credit demand in the first quarter. The number of loan applications rejected by banks reached its highest level since the regulator began keeping relevant statistics (i.e., since 2015). The review states that the overall level of interest rates “was the main factor in reducing demand for loans amid tightening monetary policy conditions.”
At the same time, the chief economist of the European Central Bank, Philip Lane, previously stated that the pace and scale of increases would depend on incoming data – in particular, the dynamics of inflationary growth, a review of bank lending, and the dynamics of economic growth.
By the way, the latest data on the growth of the eurozone economy also came out in the “red zone.” Europe did not slide into a recession but demonstrated minimal growth. In the first quarter of 2023, the GDP of the eurozone countries grew by 0.1% quarterly, which turned out to be below the expected growth of 0.2%. In annual terms, the indicator grew to 1.3%, with a forecast of growth to 1.4%.
The hawks are still in the game
Although many fundamental factors indicate a high probability of implementing a 25-point scenario, raising rates by 50 points can only partially be ruled out. Representatives of the ECB’s “hawkish wing” have repeatedly stated that the regulator at the May meeting will choose between two options, as price growth remains consistently high. According to the “hawks,” overall inflation in recent months has decreased only due to the base effect. In contrast, the stability of core inflation and wages “has prepared the ground for another rate hike of 50 basis points.”
Some currency strategists at major banks also do not rule out a hawkish scenario. In particular, according to Danske experts, the European regulator will raise rates by 50 basis points in May and at least once more – in July, by the same amount. At the same time, analysts of another investment bank – Brown Brothers Harriman – state that today there is about a 40% probability of a rate hike of 50 points at the May meeting. Experts expect a further price in another rate increase of 25 points in June and another 25-point increase in July.
Conclusions
The market has decided that the European Central Bank will raise rates by 25 basis points at the end of the May meeting. If this scenario is implemented, the main focus will be on the tonality of the accompanying statement and the rhetoric of Christine Lagarde. If the regulator indicates that the CB has only changed the pace of monetary policy tightening but still sees several more increases, the euro will be supported across the market. If, on the other hand, the Central Bank voices cautious theses, pointing to the emerging trends towards slowing inflation, the single currency will be under significant pressure.
The “hawkish option” is also possible, in which the ECB will raise rates by 50 points and leave the door open for further policy tightening. Since this scenario is not the baseline, it will trigger strong volatility in pairs involving the euro, naturally favoring it. The EUR/USD pair will not be an exception here. It is not advisable to talk about any specific price levels at the moment, as the market has not yet played out the results of the May FOMC meeting, which is an important puzzle in the “pricing” EUR/USD issue.
As we can see, the intrigue on the eve of the next ECB meeting is preserved. In conditions of such uncertainty, EUR/USD traders should take a wait-and-see position: the pair will soon enter a zone of strong price turbulence.
The material has been provided by InstaForex Company – www.instaforex.com
The intrigue surrounding the possible outcomes of the meeting will persist until the last minute: there is no consensus in the market on how much the Central Bank will raise interest rates. The fact of the increase is not up for debate, but the scale of monetary policy tightening and its further prospects are open questions.
The balance of opinion leans towards implementing a 25-point scenario. Specifically, 57 out of 69 economists surveyed by Reuters believe that the ECB will raise rates by 25 basis points at its May meeting. At the same time, 12 respondents predicted a 50-point rate increase.
Baseline scenario
Several fundamental factors support the “moderate” development path, considered a “baseline” scenario.
For instance, Eurostat published April data on inflation growth in the Eurozone countries yesterday. The release puzzled market participants with its contradictory results. The consumer price index has consistently decreased for five months (from November to March inclusive), reflecting a slowdown in overall inflation. However, in April, it showed an upward trend, rising to 7.0% (from the previous value of 6.9%). On the other hand, the core CPI, excluding energy and food prices, has slowed its growth for the first time in the past nine months, standing at 5.6% (after reaching an all-time high of 5.7% in March).
These ambiguous results puzzled the “hawks,” especially against the backdrop of declining inflation rates in Germany. The German consumer price index, expressed annually, fell in April to 7.2%, with a forecast decline to 7.3%. The annual Harmonized Index of Consumer Prices (HICP), which the ECB prefers to use for measuring inflation, came in at 7.6%, while most experts predicted a rise to 7.8%.
Another argument favoring implementing the 25-point scenario is the ECB’s quarterly review of bank lending, which pointed to a sharp drop in credit demand in the first quarter. The number of loan applications rejected by banks reached its highest level since the regulator began keeping relevant statistics (i.e., since 2015). The review states that the overall level of interest rates “was the main factor in reducing demand for loans amid tightening monetary policy conditions.”
At the same time, the chief economist of the European Central Bank, Philip Lane, previously stated that the pace and scale of increases would depend on incoming data – in particular, the dynamics of inflationary growth, a review of bank lending, and the dynamics of economic growth.
By the way, the latest data on the growth of the eurozone economy also came out in the “red zone.” Europe did not slide into a recession but demonstrated minimal growth. In the first quarter of 2023, the GDP of the eurozone countries grew by 0.1% quarterly, which turned out to be below the expected growth of 0.2%. In annual terms, the indicator grew to 1.3%, with a forecast of growth to 1.4%.
The hawks are still in the game
Although many fundamental factors indicate a high probability of implementing a 25-point scenario, raising rates by 50 points can only partially be ruled out. Representatives of the ECB’s “hawkish wing” have repeatedly stated that the regulator at the May meeting will choose between two options, as price growth remains consistently high. According to the “hawks,” overall inflation in recent months has decreased only due to the base effect. In contrast, the stability of core inflation and wages “has prepared the ground for another rate hike of 50 basis points.”
Some currency strategists at major banks also do not rule out a hawkish scenario. In particular, according to Danske experts, the European regulator will raise rates by 50 basis points in May and at least once more – in July, by the same amount. At the same time, analysts of another investment bank – Brown Brothers Harriman – state that today there is about a 40% probability of a rate hike of 50 points at the May meeting. Experts expect a further price in another rate increase of 25 points in June and another 25-point increase in July.
Conclusions
The market has decided that the European Central Bank will raise rates by 25 basis points at the end of the May meeting. If this scenario is implemented, the main focus will be on the tonality of the accompanying statement and the rhetoric of Christine Lagarde. If the regulator indicates that the CB has only changed the pace of monetary policy tightening but still sees several more increases, the euro will be supported across the market. If, on the other hand, the Central Bank voices cautious theses, pointing to the emerging trends towards slowing inflation, the single currency will be under significant pressure.
The “hawkish option” is also possible, in which the ECB will raise rates by 50 points and leave the door open for further policy tightening. Since this scenario is not the baseline, it will trigger strong volatility in pairs involving the euro, naturally favoring it. The EUR/USD pair will not be an exception here. It is not advisable to talk about any specific price levels at the moment, as the market has not yet played out the results of the May FOMC meeting, which is an important puzzle in the “pricing” EUR/USD issue.
As we can see, the intrigue on the eve of the next ECB meeting is preserved. In conditions of such uncertainty, EUR/USD traders should take a wait-and-see position: the pair will soon enter a zone of strong price turbulence.
The material has been provided by InstaForex Company – www.instaforex.com
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