In the interest rate announcement, ECB President Jean-Claude Trichet said that the bank had chosen to keep the bench mark interest rate at 1.25% and that there would be no rate hike before July. While the bank’s decision to maintain rates was broadly expected by the market participants, they were surprised about the ECB not hiking the rate in June.
Prior the announcement, the market had believed that Trichet would be at least slightly hawkish and would hint at a rate hike next month. As for the outlook, he indicated that it was “balanced,” but the economic environment was still full of uncertainties.
But what really got the market players going was Trichet dropping the words “strong vigilance” in his statement. Recall that in the March meeting the market went all bullish on the euro on due to big man Trichet’ s promise that the central bank would exercise strong vigilance over the rising inflation (i.e., raise rates swiftly if needed).
Minutes after the event, the euro staged a massive drop across the board, with EUR/USD falling to 1.4510 from 1.4823. If you did the math, you would’ve seen that that the pair had dropped more than 300 pips, roughly equivalent to how much the pair moves in an entire week. If you were bullish on the euro, then you probably felt what I felt when the Laker’s lost twice despite its home court advantage! Ouch!
How can omitting just one word from a statement could send the euro plunging across the board? You’re saying that just because Trichet didn’t include the words “strong vigilance,” the euro dropped more than 300 pips?
Yes, that’s what I’m saying.
In the foreign exchange market, even the little things count. Let’s take a quick look at how the central bank‘s statement has progressed over the last three times and the resulting move on EUR/USD.
|ECB Statement||Maintained rate at 1%, but hinted at a hike the following month||Increased the rate by 0.25% and said that they would be strongly vigilant over rising inflation||Kept rates unchanged and dropped the words “strongly vigilant”|
|Resulting EUR/USD move||120-pip rise||60-pip rise||300-pip drop|
What’s going to happen now?
Obviously, the earliest rate hike we could see out of the ECB will be on July. The combination of profit taking and traders pricing OUT their expectations for a rate hike next month will continue to give the euro bulls a major headache. There are probably a lot more stops on the way down, especially those of longer-term traders, which could mean more losses for the euro.
In any case, watch out inflation figures in the coming months as they will determine how hawkish the ECB will be. The ECB expects inflation to top out at around 2.5%, but if it unexpectedly surges, we could see the ECB go hawkish on interest rates again, which could lead to rally in the euro.