Euro unable to hold onto ECB gains

It seemed that today's ECB meeting would not bring any surprises and would basically remain overshadowed by the Federal Reserve or even the SNB. Although all four major central banks- Fed, SNB, BoE and ECB, have raised interest rates by 50 basis points this week, however the European Central Bank presented the most hawkish rhetoric. This is a big surprise that can significantly affect many markets.

The key is the fact that President Christine Lagarde has clearly communicated that the ECB will not pivot. This means that the ECB is not changing direction of its policy and slowing down the pace of rate hikes is only a small adjustment to the long-term plan. According to Lagarde, we should expect a few more hikes, in fact, at least three hikes of 50 basis points have been announced. At the same time, Lagarde pointed out that the current market expectations regarding interest rate peak around 3% are incorrect. This means that the market has greatly underestimated what the ECB can do. However, this is not the end!

The ECB changed its inflation projections significantly, indicating that the inflation target will not be reached in the forecast horizon, i.e. until 2025! Projections of the European Central Bank show that the ECB cannot withdraw from the tightening process at this point, even if inflation has recently slightly retreated (currently10%).

In addition, the European Central Bank is starting an official balance sheet reduction, specifically the APP balance sheet. The reduction is due to start in March and is expected to run through the middle of the year at the level of EUR 15 billion. In addition, the reduction of the balance sheet has basically already started due to early repayments of the TLTRO programme. Taking all these factors into account, it is clear that the European Central Bank wants to regain its credibility and reassure the citizens of the euro area and the market that it is able to bring inflation back to target. Moreover, after Lagarde's press conference ECB sources revealed that more than one-third of ECB officials wanted to hike by 75 bps, which indicates that more and more policymakers are becoming more hawkish. This, in turn, is great news for the euro, which over the last two years has been very strongly sold off against the dollar, although not necessarily good news for European equity markets. It seems that after recent announcements from the ECB, there is a chance that EURUSD pair could move towards 1.10 level, which acted as key support in the past.

Christine Lagarde said today that the ECB will not take into account the moment when the Fed stops raising interest rates. “The ECB is in the long game and the ECB is not pivoting.” This sentence can be partly compared to the words of Mario Draghi, who indicated that he would "do everything to save the euro". At that time, the situation was a bit different and inflation had to be boosted, but in the end the eurozone did not collapse. The question is- will Christine Lagarde be able to restore credibility in the Eurozone this time and bring inflation back to target?

Despite all of the hawkish narrative EURUSD pair was unable to hold onto the gains. Most popular currency pair fell sharply in the afternoon after setting a new local high around 1.0738 and is currently approaching major support at 1.0600. Source: xStation5