The Fed puts the brakes on the ECB completely

The ECB is opening the door to curb inflation with an interest rate hike in 2022. As long as other countries step on the brakes much harder, the question is whether the euro can maintain recent gains.

Will it still happen this year? At the beginning of February, ECB President Christine Lagarde noted that inflation could be above the official target of almost 2% for some time. Contrary to previous interviews at the end of last year, this time she did not mention that interest rates in the eurozone will remain unchanged in 2022. Economists and currency traders saw this as a clear indication that one or two rate hikes are imminent before the turn of the year. Without specifically warning of an interest rate move, Lagarde thus caused the euro to rise nearly 3% against the dollar within days to its highest level since the first half of November.

Greek debt crisis
If the ECB raises interest rates, it would be the first time since 2011. Perhaps it's nice to put that into perspective: at that time, the Netherlands was still vice world champion and the Greek debt crisis still had to be solved. Before an interest rate hike is discussed, however, the bank must first stop the buying program for government bonds and other assets. Several ECB executives have already hinted that the bank will release an official plan next month. It may be hard after that. Investment banks Goldman Sachs and Deutsche Bank are already taking into account that the buyback program will end in June. The interest rate could then be raised by two steps in the autumn to a rate of 0%.

Getting used to the idea
Does the turnaround in ECB policy signal the start of a euro advance? So far, that chance doesn't seem very great. The main reason why the currency is rebounding after Lagarde's allusion is that financial markets have to get used to the idea that there will come a time when the extremely low European interest rates will rise again. However, any measures taken by the ECB are child's play compared to what is happening in other countries. Across the Channel, for example, the Bank of England (BoE) already raised interest rates at the end of last year. A second increase followed just before Lagarde's comments. It is already apparent that the BoE will turn the interest rate knob again in the course of 2022.

Braking skills of the Federal Reserve
The US Federal Reserve has not yet adjusted interest rates. But all indications are that, like the BoE, the bank is going to step on the brakes much harder to curb inflation than the ECB intends. Currently, economists and traders are anticipating five or probably even six rate hikes in 2022. In that case, the US interest rate would end up at 1,5% by the end of this year. Moreover, the expected inflation in the eurozone for 2023 is below 1%. If that forecast does not go up, the ECB has little reason to raise interest rates further next year. For the time being, it therefore seems that the interest rate tailwind for the euro is temporary and that attention will soon shift to the braking skills of the Fed.

Joost Derks

Joost Derks is a currency specialist at iBanFirst. He has over twenty years of experience in the currency world. This column reflects his personal opinion and is not intended as professional (investment) advice.

© DCA Market Intelligence. This market information is subject to copyright. It is not permitted to reproduce, distribute, disseminate or make the content available to third parties for compensation, in any form, without the express written permission of DCA Market Intelligence.