Trichet was very hawkish in his press conference and sounded extremely worried about commodity prices and second round inflation effects.
The financial markets have picked up on three aspects of his speech:
1. that the ECB are using strong vigilance to ensure inflation expectations remain well-anchored and second round inflation effects are avoided.
2. That he omitted the phrase interest rates are appropriate, which clearly lays the ground work for a near-term hike.
3. But he made it clear that a rate hike in the near-term did not signal the start of a prolonged tightening cycle.
This sent EURUSD flying up to 1.3950, and 3-month swap rates have surged to their highest level since February 2009. This points to EURUSD above 1.4000 in the near-term, as you can see in the chart below:
It now looks like the ECB could hike before the Bank of England, which is weighing on sterling versus the single currency. The spread between German and UK 2-year bond yields, which is extremely sensitive to interest rate expectations, has also surged in Germany's favour to levels last seen in November 2010, when EURGBP was trading at 0.88. So the onus is for higher EURGBBP.
Overall, Trichet has lent the euro some rocket fuel. But I'm a little surprised that EURUSD didn't hit 1.4000 during the speech. I think this may be because he emphasised that a hike in the near-term wasn't the start of a prolonged tightening cycle - so the ECB isn't just thinking about Germany, it is also thinking about the weak peripheral economies when it sets policy.
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Kathleen Brooks| Research Director UK EMEA | FOREX.com
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