Will the ECB surprise the markets on Thursday?
The European Central Bank (ECB) will decide its next monetary move on Thursday 7 July at 11:45 GMT. This time around the market is pricing in the second interest rate hike following the financial crisis three years ago.
The story about Greece was a headache which lasted for weeks as the country tasted the risk of default. The euro was falling against all its major counterparts as the future of the eurozone seemed far from promising. But somehow right before the ECB's rate decision, another bailout was approved for Greece calming investors who feared a catastrophic Greek default. The Greek Parliament approved a five year 78 billion euro new austerity plan, an unpopular plan with further tax hikes and deep spending cuts that caused protests from Greek citizens. Focus now shifts from the eurozone's debt crisis and turns to the ECB and Thursday's interest rate decision. Despite the eurozone's debt problems, the ECB does not seem to have changed its plans for further monetary tightening.
During the last interest rate meeting ECB, President Jean Claude Trichet expressed the central bank's growing concern about higher price levels. Trichet said that strong vigilance is warranted indicating another rate hike in July. The Consumer Price Index revealed that prices remain elevated revealing a 2.7% gain in June, which is well above the central bank's target, supporting the view that the eurozone is facing inflation pressures. The acceleration of inflation acts as a catalyst for the ECB to act to restore price stability in the region. The economic rule is simple: when prices go up, interest rates must also go up so that demand is lower and inflation is controlled. Against the US dollar, the single currency managed to break above the 1.45 level and hit a one month high at 1.4577.
But still there is a great uncertainty surrounding the euro as debt problems in the eurozone are far from over. Investors continue to be cautious about Greece while rating agency Standard & Poor's said that a debt rollover plan for Greece puts the country at risk as it may cut the country's rating to a selective default. Despite the ECB President's 'strong vigilance' and rate hike signals, the possibility that the ECB will delay the next interest rate hike is alive. It seems that the market has already priced in expectations for a 25 bps increase in July. How the euro will react to Thursday's interest rate announcement will depend on Trichet's words during his press conference and what his views on the health of the eurozone economy are.
If the ECB hikes the rates by 25 bps then this may help the euro extend to fresh highs. Another scenario would be a 50 bps rate increase, which may surprise investors and help the euro extend higher. What will be interesting to learn is whether the ECB will commit to a series of rate hikes which may boost the euro further more. Also, let's not rule out the scenario where no rate hike occurs and instead the ECB decides to hold off from changing its policy for some time. A scenario such as the latter would disappoint investors and the excess volatility would cause the euro to plummet.
Will we witness the euro jumping to fresh highs or will the ECB knock the euro to a lower ground? 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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