05.05.2023 – The European Central Bank has done it again: It has raised key interest rates in Euroland. Only moderately. But unlike the Federal Reserve in the U.S., the monetary guardians in Frankfurt made it clear that they would continue with the interest rate steps.
The Council of the European Central Bank announced an increase of 0.25 percentage points. The key interest rate in the euro zone thus climbed to 3.75 percent. This was the seventh increase in a row, there had previously been three increases of 0.50 points. The euro has gained slowly but steadily against the dollar in recent weeks, here is the daily chart. And there are good reasons for that: There is some pent-up demand for tightening in this country.
Source: Bernstein Bank GmbH
In America, even higher interest rates are tempting, because there the Federal Reserve has just raised the Fed Funds Rate to 5.00 to 5.25 percent. But ECB chief Christine Lagarde yesterday assured that, unlike the Federal Reserve in Washington, the ECB is not thinking of sticking with the interest rate steps.
Inflation in Euroland
So the era of rising interest rates is likely to continue, because the target rate of inflation of 2 percent is still a long way off. For example, inflation in the eurozone was 6.9 percent in March 2023. More interest rate hikes in Euroland are expected to follow, and the balance sheet is expected to shrink faster.
Michael Heise, chief economist at HQ Trust expressed, “Unlike its sister central bank in the U.S., however, it does not have a time-out for further rate hikes. Another rate hike is likely as early as June, as increased wage cost pressures and the given scope for companies to raise prices mean that significant price increases can still be expected, especially in the service sector.” And Jörg Krämer, chief economist at Commerzbank, also told Reuters, “Even after seven interest rate hikes in a row, there is still a lot of work ahead of the ECB. (…) The ECB will have to step up more than once to bring inflation back to two percent permanently.”
The ECB and the banks
We suspect that long positions in EURUSD will now continue to be diligently built up. In other words, money from existing U.S. bonds could flow into new European government bonds. Because the latter yield higher than the former. It is true that new US bonds would also offer themselves to investors. But the Fed could be forced to put the brakes on tightening because of the bank turmoil in the USA. Or even do a backward roll and cut interest rates. Moreover, greater trouble in the banking sector could lead to emergency sales of government and corporate bonds and thus to losses.
In Europe, on the other hand, the situation seems more stable recently after the Credit Suisse exit. Not for nothing do we see an uptrend in EURUSD since the beginning of March. The difference in the banking sector is that in the USA – to put it exaggeratedly – in the course of cheap money, every pseudo-cool hipster with a strange business idea without sales or profit received a loan. Which also resulted in a bubble in the commercial real estate market. In Europe, on the other hand, lending traditionally runs more conservatively anyway, and startup business is often in the hands of large corporations. In other words, a bubble is unlikely to burst in this country, but it will in Silicon Valley. We are curious to see what will happen in the forex market and wish you successful trades and investments!
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