“Dovish” ECB rate hike, market reaction incomprehensible

Nevertheless, the European Central Bank surprised with an increase in interest rates by 25 basis points. The market consensus indicated no changes. However, the market received a signal that yesterday's move was probably the last one and that is why the euro lost its value EUR / USD exchange rate fell to around 1,0630. The yield on German 10-year bonds dropped significantly, reaching below 2,6%.

The market reaction is incomprehensible

The market reaction might seem incomprehensible at first glance. The euro lost value and bond yields fell. Financial market participants apparently believe yesterday's decision reduced the likelihood of further interest rate increases.

The quote in the press release read: "Based on its current assessment, the Governing Council considers that the ECB's key interest rates have reached levels that, if maintained for a sufficient period of time, will make a significant contribution to bringing inflation back to the target in a timely manner."

The same sentiment was repeated by Christine Lagarde at the press conference. Additionally, the president EBC emphasized that in addition to the level of the interest rate, its duration is also crucial.

No changes to the asset purchase program

The new ECB macro projections will support market participants' view of the end of the monetary tightening cycle. Although ECB experts slightly increased the inflation forecast for 2023 and 2024 due to the recent increase in energy prices, they lowered it slightly for 2025. At the same time, the baseline forecasts for 2024 and 2025 have been slightly revised Down. The slightly more favorable inflation outlook in the medium term is probably due to lower economic growth forecasts.

In summary, the ECB's view can be as follows: the current monetary policy is working and suppressing economic growth, which ultimately affects inflation. The bank did not introduce any changes to its asset purchase programs (APP and PEPP). Lagarde admitted that the topic had not been discussed in the Governing Council.

The ECB, of course, cannot completely rule out further increases at this point. However, the course of the conference indicated that this was becoming very unlikely. This view became increasingly common in the markets. The euro was losing and shares were rising. DAX was higher by almost 1 percent. and today it opened much higher. Today's increases are due to, among others, due to good macro data from China, which we learned early in the morning. Retail sales increased by 4,6%. y/y (the forecast indicated 3 percent) and industrial production was 4,5 percent. y/y (expected 3,9%).

Source: OANDA TMS Brokers