Prepare for Thursday's ECB interest rate decision
The European Central Bank (ECB) is deciding on its next monetary move on Thursday 7 April at 11:45 GMT. This time around the market is pricing in the first interest rate hike following the financial crisis three years ago.
During the last interest rate meeting ECB President Jean Claude Trichet expressed the central bank's growing concerns on higher price levels. Trichet said that 'strong vigilance' is needed indicating a rate hike as soon as April. Consumer Price Index revealed a higher than expected 2.6% gain in March adding to the expectations that rates will go up on Thursday. The acceleration of inflation in March may act as a catalyst for the ECB to act in order to restore price stability in the region. Other ECB members also appear to support an early monetary tightening. Bini Smaghi and Jurgen Stark joined the hawkish side by saying that rates need to gradually increase in the following months. It seems that central banks face inflation fears after Japan's massive earthquake and the ongoing unrest in Libya. Oil and commodities reached record high levels making it more difficult for central banks to decide on their next monetary actions.
Following the ECB's and Trichets hawkish stance as of late, investors have probably priced in that the ECB will vote for a 0.25% interest rate hike this Thursday. When Trichet was asked if an increase by more than 25 bps is possible he replied that is not the appropriate interpretation in my opinion. While investors consider Thursday's decision 'a done deal' the question remains whether Trichet will signal a series of rate hikes to come.
The euro gained during the last weeks supported by ECB hawkish comments. Despite continuous downgrades of euro zone periphery countries, the single currency managed to break above the 1.42 level versus the dollar and hit a five month high at 1.4286. It seems that the market has already priced in expectations for a 25 bps increase in April. How the euro will react to Thursday's interest rate announcement will depend on Trichet's words during his press conference. The different scenarios vary between a 25 bps rate hike marking the beginning of a tightening cycle, a 25 bps hike followed by a pause and, let's not rule out the possibility of, no increase at all this month.
If Trichet decides that this is a one off rate hike then this may trigger a euro sell-off. But if Trichet indicates that this is the beginning of the central bank's monetary tightening and more rate hikes will follow then this will push the euro to fresh highs. Another scenario would be a 50 bps rate increase, which again may surprise investors and help the euro extend higher. It all depends on what Trichet has to say about the central bank's economic views and intentions.
Will we witness the euro jumping to fresh highs or will the euro suffer the consequences of Trichet's words? Whatever the outcome, Thursday will definitely add color to Europe's economic picture. It will certainly be an interesting day to trade the currency markets. Get ready for a volatile and exciting market.
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