ECB goes with 50

The European Central Bank hiked its policy rates by 50bps at its March meeting, prioritizing its fight on inflation over financial stability concerns. The first line from the March statement was unequivocal about where the ECB’s focus is: “inflation is projected to remain too high for too long.” The ECB said that the “elevated level of uncertainty” meant that they would take a “data-dependent” approach to setting policy, rather than making relying on forward guidance to help shape policy and markets’ assumptions of policy directions. That should provide some flexibility on the next steps taken by the bank if inflation does start to slowdown and strain in financial markets persists, moving by 25bps for instance should data unfold as the ECB expects.

The bank also noted that the overall eurozone banking system is “resilient” as it monitors the financial stress stemming from the collapse of Silicon Valley Bank and strains on Credit Suisse but also said that it stood by to provide “liquidity support” as needed.

The ECB lowered their inflation forecasts for 2023 to 5.3% from 6.3% previously, a sharp drop likely driven by lower energy price expectations. Inflation will get closer to target levels over the next two years with CPI to slow to 2.1% by 2025 as per the bank’s projections, still slightly above target levels. Core inflation was revised higher though to 4.6% on average for this year before slowing to 2.5% in 2024 and 2.2% in 2025.

Asset purchases will continue to slow—EUR 15bn per month until the end of June—but the ECB said it will be flexible to support liquidity in the eurozone financial system as needed.

Market reaction to the ECB was muted by the standards of the last few days of trading. EURUSD wavered around either side of the 1.06 level but ultimately closed the day higher by 0.3% at 1.061. Bond markets showed more movement with the 2yr Schatz yield closing the day up 20bps at 2.573% though that was largely down to a wide opening rather than a substantial reaction to the ECB.

Markets are pricing in around another 25bps of hikes at the next ECB meeting in early May but that rates will be held for the remainder of the year. That contrasts with pricing for Fed policy where markets are still expecting rates to move lower by the end of 2023, setting up a supportive case for EURUSD in the near term.