Euro on rise as traders now see ECB as more hawkish than Fed

(Alliance News) - Market participants now believe the European Central Bank to be on more hawkish footing than its US counterpart, a prospect which once seemed unlikely and a far cry from the Frankfurt-based institution's stint in negative interest rates.

The ECB's first hike since the pandemic era of low rates was in July. By then, the Federal Reserve had enacted 150 basis points worth of hikes to tame inflation.

The euro hit an intraday high of USD1.0924 on Monday, its best level since April 2022. Since then, the euro fell below dollar parity, trading as low as USD0.9532 in September.

The single currency was hit by a European energy crisis, a poor economic outlook for the eurozone and a Federal Reserve which was viewed as ostensibly more hawkish than its European counterpart.

Things have changed since then. The ECB has acted tougher on inflation, lifting rates by 75 basis points in November and by half a point in December. It had raised rates by 50 basis points in July and 75 in September.

December's decision took the interest rate on the main refinancing operations and the interest rates on the marginal lending facility and the deposit facility to 2.50%, 2.75% and 2.00%, respectively.

In an interview with Dutch broadcaster WNL on Sunday, ECB governing council member Klaas Knot said two further 50 basis point hikes should be expected in February and March.

"Expect us to not be done by then and that more steps will follow in May and June," Knot said, in comments reported by Reuters.

Analysts at Commerzbank commented: "If we compare what is coming out of the Fed and the ECB the contrast could not be starker. On Friday once again three Fed officials, the President of the Philadelphia Fed Patrick Harker, the President of the Dallas Fed Lorie Logan and Fed governor Christopher Waller, once again supported a reduction of the rate hike speed to 25bp per meeting.

"At the same time Klaas Knot, head of the Dutch central bank favoured a 50bp step on the part of the ECB, not just next week but also beyond that. Following ECB President Christine Lagarde's and the governor of the Finnish central bank Olli Rehn’s comments along similar lines we have another ECB board member who contradicts rumours that the ECB was going to switch down to 25bp rate steps following the February decision."

The ECB's July lift was its first in around 11 years, calling time on a period of negative interest rates. Until then, rates had remained at levels seen in September 2019, back when Mario Draghi was at the helm.

In contrast to the ECB's hawkishness, the market expects the Fed to dial back on the pace of rate hikes.

According to the CME FedWatch tool, there is a 99% chance of a 25 basis point hike from the US central bank on February 1.

The ECB announces its first rate decision of the year a day later, an hour or so after the Bank of England also make a policy announcement.

By Eric Cunha, Alliance News news editor

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