ECB Monetary Policy: Inflation And the Euro
In the last few months, the European Central Bank (ECB) faced high inflation levels that have forced it to review and radically change its monetary policy. The euro itself has not remained unaffected by the inflationary onslaught, losing ground against its main competitor, the US dollar.
The euro is among the most traded currencies in the world along with the US Dollar and the British Pound. This blog will share valuable insights for beginner traders who’d like to trade the euro regarding the bloc’s inflation and the central bank’s monetary policy forecast.
Eurozone Inflation Surges To Record-Highs
The European Central Bank had set a 2% headline inflation target. For many years the ECB’s governing board was able to deliver monthly inflation rates close to its target and sometimes close to 0. Eurozone’s central bank managed to keep inflation in check in the last decade, although interest rates were kept close to historical lows.
The coronavirus pandemic forced the ECB to reduce interest rates even more in order to support the euro bloc’s economy which suffered from lockdowns and other government-implemented measures. Salaries were paid despite the reduced economic activity and a special fund with the aim of supporting the eurozone’s economies was created.
The consequences of the influx of billions of euros in the market became apparent in August 2021 when headline inflation came in at 3.0%, 0.8% higher than July’s figure. By February 2022, inflation had risen to 5.9% continuing on its upward trajectory until October 2022 when it reached 10.6% on a year-to-year basis. Since then, the inflation level has dropped close to 7%, still far away from the ECB’s 2% target.
ECB Interest Rates Rise To Control Inflation
One of the strategies that the ECB’s governing board chose to reduce inflation levels was to raise borrowing costs. In July 2022, the board announced the first rate hike in eleven years. By May 2023, the ECB raised interest rates seven times in a row with its main deposit rate coming in at 3.25%.
The ECB is not the only major central bank that has tightened its monetary policy in the past few months as the US Federal Reserve and the Bank of England have raised borrowing costs considerably to curb inflation.
How Does The Euro React?
The days that the euro was trading at $1.22 (May 2021) against the US dollar are long gone. The single currency’s value dropped in the next few months, recording a multi-year low at the beginning of September 2022, when it traded at $0.98 against the US currency.
The euro has gained ground on the back of repeated interest rate hikes by the ECB, breaking the $1 barrier and trading at $1.08 on May 18th.
What Do Analysts Suggest Regarding The Eurozone Economy And The Euro?
The cost of living has risen considerably in the last few months for most Eurozone citizens. People who have to repay their loans have had to spend more money as higher rates have taken a toll on their available budgets. Although headline inflation seems to be falling month by month, there is uncertainty about whether the ECB will continue to tighten its monetary policy in the future.
ECB's Christine Lagarde: No Pausing Yet
The head of ECB Christine Lagarde said that “we are not pausing - that is very clear. We know that we have more ground to cover. Inflation has been too high and for too long, the ECB is on a journey to fight inflation, and the fight is not over, and it will only be over when we have sufficient confidence that we will reach the 2% target in the medium term.”
When asked if the ECB would follow the Federal Reserve into pausing interest rate hikes, Lagarde noted that the ECB is not Fed-dependent and added that recent wage deals and high corporate profit margins could pose a risk to the central bank’s monetary policy plan.
Reuters Poll Suggests 2 More Rate Hikes
All 62 economists polled by Reuters on May 16th forecast a 25-basis points hike in the ECB’s June meeting. Forty-two economists also forecast one more 25-basis point rate hike in July. The majority of economists suggested that after the anticipated rate hikes, interest rates are not expected to change until April 2024.
Bank Analysts’ Forecasts
A report by the Bank of America seems to agree with the Reuters poll findings. “The messaging from several ECB speakers ... has clearly been on the hawkish side since the (May 4) meeting, and their consumer expectations survey just showed higher inflation expectations. Unless something breaks, we can only reiterate our view that - despite the cracks appearing in the outlook - two more 25 bps hikes are the lower bound" is noted in the Bank of America report.
ING’s analysts said in their report, published on May 4th, that “it will be hard for the ECB to return to 50bp rate hikes in the current macro environment with the lagged impact from previous hikes, banking turmoil, and subdued growth but still sticky inflation. In this base case scenario, it will be equally difficult to hike rates more than one or at most two times. In fact, the risk is high that every single additional rate hike from here could turn out to be a policy mistake further down the road. Instead, keeping interest rates high for longer after another rate hike in June will probably be the next compromise between the doves and hawks.”
Analysts at the Finnish bank Nordea suggested that financial markets are pricing in too many rate cuts ahead. Commenting on interest rates, they said: “Earlier tightening measures are having a clear impact on financing conditions, banking worries in the US continue, but at the same time, inflation numbers remain way too high. There are clearly risks both ways, but we think at least the ECB will hike rates several times further, and do not see rates falling as rapidly as being priced in by financial markets. Lagarde was clear that the ECB is not pausing, and we look for two further 25 bps rate hikes, in June and July, bringing the deposit rate to 3.75%.”
Trading The euro For Beginners And Managing Risks
The euro is considered one of the top major currencies traded every day in global markets. The single currency is traded against the US dollar and the British pound but also against the Japanese yen or other currencies coming from emerging markets. The currency pairs based on the euro are many, helping traders to diversify their strategies depending on their goals. As the single currency is one of the most popular currencies among traders, beginner traders could be exposed to increased euro-related publicity.
If you just start your trading journey, you might try to find trading opportunities based on euro-based currency pairs. However, it is quite possible that you won’t have the necessary experience to judge which would be the right course of action and engage in trading based on emotions rather than knowledge.
Risks are always high for beginner traders. If you wouldn’t like to lose funds unexpectedly, it would be best to amplify your knowledge around trading and learn how to use risk management tools. For example, a stop-loss order enables traders to limit their potential losses when trading. There are many risk management tools that you can learn how to use. Brokers offer a broad range of educational materials prepared by experienced traders that could prove useful to beginner traders. We invite you to boost your skills by studying how to use the necessary tools that could help you reduce risks and enjoy the trading experience at the same time.
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This material does not contain and should not be construed as containing investment advice, investment recommendations, an offer of or solicitation for any transactions in financial instruments. Please note that such trading analysis is not a reliable indicator for any current or future performance, as circumstances may change over time. Before making any investment decisions, you should seek advice from independent financial advisors to ensure you understand the risks.
