The European Central Bank's (ECB) monetary policy meeting was a perfect replica of the March meeting so to speak. Foreign exchange traders learned nothing new. The ECB’s monetary policy follow-up remains unclear while all its peers have established a clear monetary tightening schedule for the coming months. The Bank of Canada raised its key rate by 50 basis points this week (which we believe will support the Canadian dollar against the euro over time).
In the US, the latest inflation figures for March (consumer prices at 8.5% year-on-year and producer prices at 11.2% year-on-year) make it inevitable that the Federal Reserve will raise its policy rate by at least 50 basis points in May. The only exception is the Bank of Japan: unlike other central banks in the developed world, it is maintaining an accommodative stance and does not plan to change direction in the coming months. This is an element that weakens the Japanese yen against the US dollar and the euro (down 6.38% and 4.88% respectively over the past month).
There are two reasons why the ECB is over-cautious:
1/ For the ECB it is still too early to know the consequences of the Russian-led war in Ukraine on the eurozone economy. We lack raw data (GDP, retail sales etc.). But we do have data from business surveys that show that the fallout from the war will be massive. The German IFO and ZEW surveys for March validate the growing risk of stagflation (low growth and high inflation) for Germany, the eurozone's largest economy. In France, the business climate index also fell in March, but to a less worrying extent. It is primarily in industry that the outlook for production has darkened considerably (mainly because of rising input costs and the difficulty of obtaining certain essential goods and materials in the production process).
2/ Many members of the ECB Governing Council consider that inflation is temporary. It is said to be mainly related to the war in Ukraine. The Governor of the Banque de France, François Villeroy de Galhau, suggested that inflation will come down by itself during his monthly breakfast with economic journalists in France. Under these circumstances, he does not understand why the ECB should act. This thesis is largely validated by the central bank's internal teams, which in their latest macroeconomic projections anticipate that the eurozone's consumer price index will return to the 2% target next year. Today, inflation is approaching 8% in the eurozone. This is illusory. Why is inflation in the eurozone temporary when everywhere else it is partly structural (and therefore sustainable)? The Bank of England, the Hungarian Central Bank and the US Federal Reserve, to name but a few, have recognised this. This makes many economists and analysts say that the ECB is behind in the economic cycle because of an initial misdiagnosis of inflation dynamics.
See you next June
In the short term, there is nothing more to expect from the ECB. Christine Lagarde has invited market participants to check back in in June: that is when a more precise timetable for monetary tightening and rate hikes could be unveiled. For the time being, the foreign exchange market is hesitating between a first increase in the cost of money in September or in December 2022. Either way, it will be too little too late, in our view. Inflation is probably already out of control. It has started to erode household purchasing power and corporate margins.
EUR/USD remains bearish in the short term
The slow reaction of the ECB could lead to a further decline of the euro against the US dollar in the short term. In the aftermath of the ECB press conference, the EUR/USD was down around 1%. This is a continuation of the downward movement that started several sessions ago. According to the weekly report published by the CFTC (Commodity Futures Trading Commission), long positions on the euro are being liquidated in favour of short positions. This is another element that should tend to push the euro down against the dollar but more broadly against all its counterparts. Contrary to other market participants, we do not consider the French presidential election to be a risk for the foreign exchange market as foreign market operators are not interested in it. We do not recommend implementing a specific hedging strategy in the run-up to the second round, scheduled for 24 April.