Thursday’s comments from ECB President Jean-Claude Trichet have gone down a treat in the foreign exchange markets.
At pixel time the euro was headed straight through a bunch of moving averages while approaching the all important psychological $1.40 mark:
So why the turn of events?
Reference by Trichet, of course, to the market’s favourite code: “strong vigilance”.
Or as the statement read:
The current very accommodative stance of monetary policy lends considerable support to economic activity. It is essential that the recent rise in inflation does not give rise to broad-based inflationary pressures over the medium term. Strong vigilance is warranted with a view to containing upside risks to price stability. Overall, the Governing Council remains prepared to act in a firm and timely manner to ensure that upside risks to price stability over the medium term do not materialise. The continued firm anchoring of inflation expectations is of the essence.
Usually interpreted by the market as code for a rate-hike by the next meeting.
That at least is the view from a whole bunch of analysts. Here, for example, is Unicredit’s Marco Valli:
1) The ECB is now in “strong vigilance” posture. In the last tightening cycle, this code word signalled the intention to raise rates at the following meeting, and there is no reason to think that things will be different this time. Moreover, the current level of interest rates is no longer seen as appropriate, and inflation risks in the medium term have moved to the upside. In the Q&A session, Trichet further cemented rate hike expectations for April, although obviously he did not pre-commit. We think that the most plausible element that could keep them from hiking in April is renewed market tensions in case of a low-profile agreement at the EU summit at the end of March.
2) In the Q&A, Trichet stated that “certainly” this is not the beginning of a tightening cycle. This seems to suggest that today’s shock announcement should be seen as a pre-emptive move aimed at anchoring inflation expectations and sweeping away any doubt that the ECB takes its mandate of price stability very seriously. After all, although CPI risks are now seen on the upside, the ECB’s central forecast for 2012 CPI is still a benign 1.7%. Accordingly, we don’t think that the ECB will hike again in June. However, an isolated rate move makes little sense, particularly now that the ECB is becoming more confident on the sustainability of the recovery – in this respect, the small 0.1pp upward revision to the 2012 GDP forecast (from 1.7% to 1.8%) is particularly telling, as well as the fact that risks to the growth outlook are now seen as balanced. Taking all these elements into account, we think that the ECB will resume hiking rates in September, and deliver another increase in December. We should end 2011 with the refi rate at 1.75%.
Citi’s Jürgen Michels says much the same:
The ECB left interest rates unchanged at 1.0%. The decision was unanimous. In the press conference, the ECB did not only drop the phrase that current rates are “appropriate”, it also said that “strong vigilance” is warranted in order to contain risks to price stability. With ECB President Jean-Claude Trichet highlighting that the code phrase “strong vigilance” suggests that an interest rate hike in the next meeting is possible, to us a rate hike by 25bp in April looks now very likely. With such an earlier-than-expected rate hike in 2Q, we expect the ECB to increase rates again by 25bp in 2H. Therefore, our new forecast for ECB rates at the end of 2011 is 1.5%, up from 1.25%. Previously we expected one hike in 3Q.
As does BNY Mellon’s Global Research team:
Given that Trichet has always maintained that the ECB never pre-commits, today’s statement and comments are truly remarkable. Trichet and the Governing Council are obviously deeply concerned about the recent rise in food and energy prices and the potential for second round effects. Judging from the statement and Trichet’s comments, the ECB is signaling in the strongest manner possible that it will be raising rates by at least 25 bps at the next meeting. While Trichet had denied that this is the beginning of a series of rate hikes, it goes without saying that he cannot fully anticipate price developments in the future.
The ECB will do whatever is necessary to maintain price stability, and further rate hikes cannot and should not be summarily dismissed. The motivation is clearly not rate normalization, but a campaign of inflation fighting. This will make the timing and extent of monetary tightening all the more unpredictable. The further that food and energy prices rise, the greater the likelihood that the ECB hikes more than 25 bps and engages in a series of rate hikes. The ECB’s message was received loud and clear. There was no ambiguity. The EUR jumped on Trichet’s early remark that “strong vigilance is warranted,” and continued to rally as risks were revised to the upside, ECB staff inflation projections were revised higher, and Trichet’s explicitly mentioned the possibility of a rate hike at the next meeting. The EUR/USD surged as high as 1.3974 by 8:45am EST from 1.3850 following the initial prepared remarks and an overnight low of 1.3833, before trading back to 1.3940 by 10am. The EUR crosses rallied just as strongly, with EUR/GBP surging to a session high of 0.8571 by 9:50am from 0.8510 following the initial prepared remarks and an overnight low of 0.8479. Similarly, EUR/CHF surged to a session high of 1.2989 from an overnight low of 1.2788 and EUR/JPY surged to a session high of 114.84 from 113.10.
We expected this to be the event of the week, and Trichet delivered in spades. This may prove in retrospect to be the event of the month if not the year for foreign exchange. Whereas the market had anticipated a rate hike as early as June, it quickly brought this forward to April with increased expectations of further rate hikes to come. The market had expected Trichet to use some finesse in his hawkish remarks today – he used a sledgehammer. While non-farm payrolls is scheduled for tomorrow, the market is expected to largely overlook it as the numbers will obviously be subject to weather-related effects. Moreover, the market focus has turned to debating what major central banks will be next in acknowledging the threat of inflation and raising interest rates. Following recent remarks by the Fed’s Bernanke, the BOE’s King, and the BOC’s Carney, it is not altogether clear that the threat of inflation is seen universally. Independent monetary tightening on behalf of the ECB will prompt a stronger EUR, not only against the USD but also in the EUR crosses.
And lastly here’s Jullian Callow from Barclays Capital:
Following today’s ECB Press Conference it is now likely that the ECB will raise the main policy rate from 1.0% to 1.25% at the next policy meeting of the Governing Council (7 April). The language being used, both in the Statement and in the Q&A, suggests that, unless some very negative force intervenes, the Council will undertake this action. While Mr Trichet mentioned that it was “possible” that there could be a 25bp rate hike in April (he also signalled it was unlikely to be +50bp), the ECB style of language should be interpreted as suggesting that this is very probable (viz., the press conference in June, 2008, where a “possible” rate increase was also signalled).
As well, the expression “strong vigilance” was used (this was not even used in June 2008, last being used in August 2007). Meanwhile, the Council announced it would continue to operate a policy of full allotment for the one week, monthly and three monthly refinancing operations during Q2. Mr Trichet was keen to stress the “separation principle”. Our previous profile had been for the ECB to raise the policy rate in September and December. We shall need to re-consider the profile in the context of today’s news, but for now the only revision is that we expect a rate increase at the 7 April meeting, given the language that has been used today, so then the question is when the next rate increase will be.
While Mr Trichet was keen to play down that the envisaged increase on 7 April would be the start of a series, this form of language is similar to that being deployed in December 2005 (yet then there was a sequence of +25bp rate increases on a quarterly basis during 2006). Hence, if anything, there would appear to be a likelihood there will be at least one additional rate increase within a few months of the April one, unless there is a major downturn in business and/or financial market conference during Q2/the summer, or if the euro continues to appreciate strongly.
In a nutshell, a major change of sentiment from the ECB.
Although also worth noting is the following reference from the statement referencing the need for a “quantum leap” when it comes to economic and budgetary surveillance in the euro area:
The current sovereign debt crisis in the euro area has reinforced the need for an ambitious reform of the economic governance framework of the euro area. The Governing Council of the ECB is of the view that the legislative proposals which have been put forward by the European Commission go some way to improving economic and budgetary surveillance in the euro area. However, they fall short of the necessary quantum leap in the surveillance of the euro area which is necessary to ensure the smooth functioning of Economic and Monetary Union. As outlined in the ECB’s opinion of 17 February 2011 on these proposals, more stringent requirements, more automaticity in the procedures and a clearer focus on the most vulnerable countries with losses in competitiveness are required to ensure that the new framework will indeed be effective in the long run.
Which not only seems like a veiled criticism of the European Commission’s handling of the current European sovereign crisis but also a semi admission that the “smooth functioning of the Economic and Monetary Union” is at stake if a radical change is not implemented soon.
We hear you Trichet.
Related links:
Why debt investors are taking leave of their senses – FT Alphaville
European liquidity and Irish handcuffs - FT Alphaville