HAWKISHNESS is not new at the European Central Bank (ECB), but this week its most notorious birds of prey have been flapping their beaks.
This has got foreign exchange traders rather excited, and stabilised the euro against the dollar at a time when the upheaval in the Middle East should have had them flooding in that direction. While the dollar did gain ground, it did not have the impact most would expect: the euro reached around $1.3653 yesterday.
The language of Yves Mersch and Juergen Stark has certainly toughened up the ECB’s stance on inflation ahead of next week’s meeting, but does this mean the board will raise rates earlier than expected?
RATE RISE IN THE PIPELINE
Most have taken the view that an ECB rate rise was in the pipeline, expecting it to come later this year. The political debate around the restructuring of its bailout fund and the periphery countries’ debts was expected to be enough to slow down the decision-making process on rates. With this consideration, BNP Paribas’s Ken Wattret said he did not expect rates to be lifted until the fourth quarter of this year.
But now he is not so sure: “The potential for further turbulence in the Middle East and the increasingly hawkish tone of the ECB makes me think a rate rise could come sooner. A string of negative market data is more likely to force their hand.”
EXPECTATIONS ARE OVERDONE
Richard Wiltshire, a currency expert at ETX Capital, however, thinks that market expectations are overdone: “Most of it is just rhetoric for now.”
Duncan Higgins, a market analyst at Caxton FX, agrees: “Unlike sterling, the market hasn’t priced in much chance of a rate rise yet. I doubt that Mersch’s comments will have drastically altered the ECB’s view.”
He argues that the Eurozone is still a hotbed of uncertainty, confidence is still low and Portuguese bond yields are hitting record highs: “The ECB will not want to risk undermining a still nascent recovery by raising rates prematurely.”
Higgins and Wiltshire may have a point. Mersch and Stark are known for holding hawkish views. Indeed Stark was once described as the very “representative of a good old Bundesbank tradition.”
SURPRISE CURRENCY MOVEMENTS
Yesterday’s surprise currency movement certainly bodes well for single currency bulls. And with inflation edging up, the ECB can relied upon to be getting concerned.
But whether a rate rise is actually due is quite another matter. The fact that the euro found a support level against the dollar amidst the Middle East crisis goes to show that the market is longing to hear more from the ECB’s hawks.