The fact that the European Central Bank (ECB) raised rates again came as no surprise. What made this decision different than the few previous ones was the elimination of the text provided from previous meetings stating that the bank would keep interest rates high for a long period of time. Markets interpreted his as a dovish move.
ECB Raises Rates by 25 bps
The ECB's decision to raise interest rates by 25 basis points was in line with market expectations.
The surprise was that there had been a significant shift from earlier meetings. The only text that was missing from the report that was released following the meeting was the passage that discussed maintaining high interest rates for an extended length of time. Otherwise, the text was virtually the same.
Door Left Open for Lower Interest Rates Soon
Investors instantly took this into account because due to its significance. The possibility of lowering interest rates in the not too far future, if the circumstances are right, seems to be there.
Additionally, the European economy is not exactly doing well, so the ECB might choose to ease up on the level of monetary policy restraint in the event that inflation levels decline.
Inflation is Showing Signs of Cooling Down
The European Gross Domestic Product (GDP) fluctuates between stagnation and contraction. Since the major economy of the eurozone, Germany, has officially entered a technical recession, boosting interest rates may not be the best course of action.
On the other hand, although being at high levels, inflation is already beginning to moderate, especially the underlying Consumer Price Index (CPI), which has increased by between 0.2% and 0.3% over the past two months.
Further Economic Data Will Determine the September Decision
Like the Federal Reserve’s Jerome Powell, the ECB President, Christine Lagarde, left the decision for the following September up in the air. Although she made it apparent that they might not hike rates this time, this choice will be made based on economic data.
The market reacted as expected after interpreting the news and Lagarde's remarks as being dovish.
European and North American Stock Markets Rose Sharply
Along the curve, European treasury rates decreased considerably. The European and North American stock markets both experienced significant gains while the German 2-year bond experienced a 5 to 9 basis point decline. Midway through the afternoon, the German DAX index was up 1.70% and was close to recent highs from mid-June.
The Euro was the asset that moved the most as a result of the ECB's dovish stance. The EUR/USD pair dropped more than 140 pips, trading under $1.00.
When the US GDP data for the second quarter, which came in far above estimates at 2.4%, was revealed, the US Dollar gained momentum and the EUR/USD began to fall.
Germany40 monthly trading chart July 28, 2023. Sources: Bloomberg, Reuters
Key Takeaways
No surprise as the ECB raises rates by 25 bps.
- The bank leaves door open for hikes to stop earlier than predicted.
- European’s GDP is moving between stagnation and contraction.
- Inflation is beginning to show signs of moderation.
- Christine Lagarde gave no hints about the September decision.
- Upcoming economic data will determine the future of interest rates in Europe.
- The market interpreted the bank’s actions and statements as dovish.
- European treasury yields fell significantly.
- The German 2-year bond fell between 5 and 9 bps.
- European and North American stock markets rose strongly.
- EUR/USD gained after US Dollar gained momentum after GDP data.
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