Pound to Euro Rate Rises in Initial Reaction to ECB Rate Hike and Softened Guidance

The European Central Bank (ECB) raised its three main interest rates by a further 25 basis points, as expected, but gave no clear indication it would hike interest rates again.

The July decision was met with an initial fall in the value of the Euro as investors lean towards the belief the central bank has ended its rate hiking cycle aimed at bringing inflation down to its 2.0% target.

In a statement, the ECB said inflation will drop further over the remainder of the year, but will stay above target for an extended period.

“The Governing Council’s future decisions will ensure that the key ECB interest rates will be set at sufficiently restrictive levels for as long as necessary,” read the statement.

One key point to note in the above: previously this element of the statement read “Interest rates will be brought to sufficiently restrictive levels”.

This subtle, yet important, change steers the ECB’s communication towards a hint that it has arrived at the peak and is now ready to pause the rate hiking cycle.

The ECB reckons past rate increases continue to be transmitted “forcefully” and have tightened financing conditions, which is acting to dampen demand.

The guidance also confirms a data-dependent approach is maintained with regard to deciding whether to raise interest rates again.

“The market is positioned long of the EUR, meaning that a lack of hawkishness in the ECB’s commentary today could leave the EUR on the back foot,” says Jane Foley, Senior FX Strategist at Rabobank.

The Pound to Euro exchange rate recovered the day’s earlier losses and was seen at 1.1660 ahead of President Christine Lagarde’s press conference.

The Euro to Dollar exchange rate retreated back to 1.1080, having been as high as 1.1150 in the hours prior.

“On the assumption that ECB rates are close to peaking we see EUR/USD trading down to the EUR/USD1.08 area on a 3month view. We see the risks for EUR/GBP as being well balanced,” says Foley.