EconomyEuro hits two-year low on ECB interest rates caution

Euro hits two-year low on ECB interest rates caution

The euro fell sharply on Thursday after the European Central Bank’s latest policy stance did not match market expectations on the pace of stimulus withdrawal.

The ECB opted to leave interest rates unchanged as expected after its latest policy meeting but president Christine Lagarde noted that “downside risks to the growth outlook have increased substantially as a result of the war in Ukraine”. Inflation will remain high over the coming months, mainly because of rising energy costs, she added.

The euro dropped as much as 1.2 per cent against the dollar after Lagarde’s comments, to a two-year low of slightly less than $1.08. It later retraced some of the losses to trade 0.5 per cent lower for the day.

Carsten Brzeski, head of macro for ING Research, attributed the drop in the currency to investors getting “ahead of themselves” in recent weeks, expecting eight interest rate rises by the end of 2023.

“Lagarde’s comments today, however, confirmed the rather gradual process of normalisation,” he said.

The central bank said economic data released since its last meeting “reinforce its expectation” that its asset purchase programme (APP) should end in the third quarter of the year.

Despite that, Frederik Ducrozet, strategist at Pictet Wealth Management, said the currency’s decline was down to the lack of a “strong hint or firm commitment” from Lagarde that the APP would end in June. “It’s a reaction to the positioning of markets ahead of the conference,” he said.

Inflation in the euro area has sailed higher over the past year, with price growth hitting 7.5 per cent last month. Both the US Federal Reserve and the Bank of England have already begun raising interest rates in an attempt to damp intense price rises, but the ECB has indicated that it must first cease its bond-buying before increasing borrowing costs.

ECB policymakers also need to balance the impact of the war in Ukraine, which is expected to take an outsized toll on Europe’s economy.

“The supply shock implied by the war implies a difficult trade-off for the governing council, given weaker growth and higher inflation,” Goldman Sachs analysts noted. The investment bank expects the ECB to raise rates in September but said a July increase would not be out of the question if inflation pressures picked up.

Eurozone government bonds weakened following the ECB decision. The yield on the 10-year German Bund rose 0.08 percentage points to 0.84 per cent, while the Italian equivalent also added 0.11 percentage points to 2.48 per cent. Yields rise when prices fall.

The regional Stoxx Europe 600 index rose 0.7 per cent, with Germany’s Dax up 0.6 per cent and France’s Cac up 0.7 per cent. The FTSE 100 in London added 0.5 per cent.

In the US, a recent rally in Treasuries went into reverse, with the yield on the government’s benchmark 10-year debt jumping 0.13 percentage points to 2.83 per cent.

Unexpectedly weak core inflation figures earlier this week had led investors to temper their expectations about how aggressively the Federal Reserve would raise interest rates, prompting a rally in bond prices. However, in an interview on Thursday John Williams, president of the New York branch of the Federal Reserve, stressed the need to move interest rates “back to more neutral levels”.

Wall Street’s benchmark S&P 500 stock index fell 1.2 per cent, after adding 1.1 per cent in the previous session. The tech-heavy Nasdaq Composite lost 2.1 per cent.

Oil prices rose on Thursday, with international benchmark Brent crude up 2.7 per cent to $111.70 a barrel.

In Asia, Hong Kong’s Hang Seng index added 0.7 per cent and China’s CSI 300 was up 1.3 per cent. Japan’s Topix rose 1 per cent and South Korea’s Kospi traded flat.

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