Back to insights News

Euro to rally as ECB shifts gears

Rates in Europe are likely to rise sooner rather than later.

Sterling rallies after EU's Barnier says UK Brexit deal 80-85 pct agreed

The European Central Bank (ECB) is likely to leave its benchmark interest rate and asset purchase programme unchanged when it meets next Thursday, 14 June. But what everyone is really waiting to hear is whether or not the central bank will spell out its strategy for ending the bond-buying scheme, which has grown to the gargantuan size of €2.55 trillion.

The ECB’s announcement on Tuesday, 5 June that the meeting will be streamed live alluded to a highly likely monetary policy change. And Governing Council members Jens Weidmann and Peter Praet have since made hawkish comments, with the latter suggesting that inflation was approaching the central bank’s 2 per cent target.

Fears of Italexit remain

The ECB’s decision will follow a period of volatility in European financial markets, which was triggered by a rise of populism in Italy. This also caused an increase in bond yields in Europe’s third largest economy, raising concerns among investors whether or not and how the newly formed government would go about reducing the size of the ballooning budget deficit.

Although concerns of deflation have subsided, the political landscape still warrants some caution from the ECB. Should Italy decide to push for an Italexit referendum, fears of contagion will spread throughout Europe. This, in turn, will drive up borrowing costs for other member states, which is highly likely to push the central bank to intervene once again.

For now, the populists in Italy are not looking to put it out to the citizens to make such a decision. Recent polls suggested the likely outcome of the referendum will be a resounding remain victory. But as we know, polls can be misleading.

Euro to strengthen

So, what is next for the single currency? Should the ECB shift towards ending quantitative easing this year, it will contrast with the Bank of England’s current wait-and-see stance. This would strengthen the Euro against the Pound. But how the single currency will perform against the greenback is less clear.

Next week the Federal Reserve (Fed) will announce its decision on the benchmark interest rate. Economists are almost unanimous that a rate hike will be introduced. But what is more important is if this will be the first in a series of hikes this year. A hawkish ECB position and a dovish Fed approach could push the Euro back up to $1.20 against the Dollar, which is a more likely outcome.

Related Insight

More Insights