23.07.202614:12 Forex Analysis & Reviews: ECB's hawkish stance supports euro

Lee Hardman, a senior foreign exchange analyst at Japanese financial conglomerate MUFG (Mitsubishi UFJ Financial Group), emphasises that ahead of the ECB meeting, euro area sovereign yields have moved to new year-to-date highs. Markets are pricing in two to three interest rate hikes in the period ahead and are almost ruling out the likelihood of an additional rise in September. These developments are consistent with Hardman's forecast that the last move will occur in September, although he warns that a further rise in energy prices would increase the risk of prolonged monetary tightness and weigh on growth in the euro area.

He also highlights that since the beginning of the year, ahead of policy meetings, yield dynamics and rate expectations for the ECB have shifted materially:

"In response to rising energy prices, market participants have been moving to price in more hawkish expectations for major central banks including the ECB and Fed resulting in short-term yields rising to fresh year-to-date highs. The eurozone rate market is now pricing in two to three further ECB rate hikes in the year ahead while the US rate market is pricing in around two Fed hikes over the same period. Short-term yields have risen more recently in Europe than in the US resulting in yield spreads moving against the USD."

"Another hike as soon as the following policy meeting in September is almost fully priced in. It fits with our own forecast for one final hike in September, although we acknowledge that the risk of an additional hike later this year would increase if higher energy prices are sustained during the second half of this year."

"We see little scope today for President Lagarde to push back strongly against market expectations for multiple rate hikes given inflation risk are increasing. Higher energy prices will add to downside risks for growth in the eurozone as well. Like in the US, the euro-zone economy has held up better than expected so far to the energy price shock providing some reassurance."