15.04.202209:21 Forex Analysis & Reviews: Euro: failure or renewal? Recession followed by rise amid monetary decisions

After the European Central Bank meeting, where issues of monetary policy were decided, the euro fell sharply. Currently, the euro currency has tried to get out of this hole, and its efforts have been rewarded. However, it is too early to talk about a confident recovery of the EUR.

The ECB meeting, held on Thursday evening, April 14, did not live up to the market's hawkish hopes for the central bank. As a result, the latter not only did not support the European currency, but also partly "drowned" it. After the ECB's decision, the national currency collapsed sharply, updating the lows since April 2020. The euro rolled back to 1.0778 on Thursday evening, alarming the markets. Later, however, the single currency began to accelerate its rise, overcoming the resistance of negative factors. On the morning of Friday, April 15, the EUR/USD pair rose to 1.0805, gradually moving higher.

The ECB expectedly kept the base rate on deposits unchanged (at the level of -0.50%). The interest rate on key refinancing transactions remained unchanged (at 0.00%) and the interest rate on margin credit (by 0.25%). The central bank decided not to wake the sleeping lion, fearing possible economic problems, so it left the current monetary policy unchanged. The only thing the ECB will be fighting with is steadily rising inflation, so a reduction in stimulus programs is expected in the coming months.

After the ECB meeting, market participants focused on comments about the central bank's future plans and were disappointed by their softness. Many believe that compared to other central banks, the ECB is losing by refusing to tighten. Recall that the Federal Reserve is preparing to curtail the quantitative easing (QE) program and raise rates immediately by 50 bp. The Bank of Canada and the Reserve Bank of New Zealand have also introduced similar measures. The Bank of England has returned interest rates to pre-pandemic levels. Against this background, the ECB looks too slow, but time will tell which of them is right.

During a press conference that took place after the central bank meeting, ECB President Christine Lagarde announced the increased risks of rising inflation in the eurozone. The department confirmed the curtailment of the QE program in the third quarter of this year. The ECB plans to reduce bond purchases under its own asset purchase program to 30 billion euros in May and 20 billion euros in June. According to Lagarde, the current geopolitical situation has an extremely negative impact on the European economy. Its dynamics largely depend on the development of the Russian-Ukrainian conflict and the impact of anti-Russian sanctions. These factors, along with galloping inflation in the euro area, create an explosive mixture that can "blow up" the euro. Lagarde noted that inflation will remain high in the coming months.

The market reaction to the ECB's statements turned out to be predictably negative. The euro's fall led to a sharp decline in the yield of eurozone bonds. As for the yield of two-year government bonds in Germany, they sank by 5 bp during the day. For many analysts, a possible recession in the eurozone is becoming the baseline scenario. However, the scale and duration of this recession largely depend on further anti-Russian sanctions. At the same time, the risk of a complete energy embargo increases, which is capable of plunging the euro bloc economy into chaos.

Over the next weeks, the ECB will focus on rising inflation and ways to overcome it. The central bank will adjust its monetary policy based on the geopolitical situation associated with the Russian-Ukrainian conflict. Against this background, many experts are counting on an increase in the ECB interest rate in the fourth quarter of this year or early 2023. At the same time, the completion of the asset purchase program in the third quarter of 2022 leaves the central bank room for maneuver and makes it possible to raise the key rate. According to analysts at ING Bank, the implementation of such a scenario "will put an end to the era of negative interest rates before the end of 2022."