• ECB makes first interest rates hike after 11 years

ECB – Expect retail trades to remain net long

The European Central Bank (ECB) hiked its interest rate by 50 basis points (bps) yesterday, the first rate hike by the ECB in over 11 years. While a 25bps hike has been fully factored in, we did not rule out a 50bps hike.

Based on this latest decision, we expect further policy rate normalisation. We are looking at another two more hikes of 25bps each in 2022. And the ECB will continue the APP reinvestments (bond buying) for as long as they are needed.

The ECB’s new anti-fragmentation tool, the Transmission Protection Instrument (TPI) will be an addition to the Governing Council’s toolkit and can be activated to counter “unwarranted, disorderly market dynamics” that pose a serious threat to the transmission of the monetary policy across the euro area.

The scale of TPI purchases depends on the severity of the risks facing policy transmission. Purchases are not restricted ex ante. By safeguarding the transmission mechanism, the TPI will allow the Governing Council to more effectively deliver its price stability mandate. This safety net will be used to keep peripheral bond yields and spreads under control.

The rate hike now raises the debt crisis in Italy, especially after Mario Draghi resigned as prime minister. This, in turn, could offset the optimism led by the resumption of Russian gas supply via the Nord Stream 1 pipeline and hold back traders from placing aggressive bullish bets around the EUR/USD pair.

We prefer to wait for details of the ECB's new anti-fragmentation tool aimed at shielding highly indebted countries from surging borrowing costs. Hence the focus remains on the post-meeting press conference, where comments by ECB president Christine Lagarde might infuse some volatility around the euro crosses.

Confidence has already been hit hard by the knock-on effects of the Ukraine conflict, as high raw materials prices press purchasing power further down, which could lead the block into recession amid looming winter gas shortages.

Raising rates in a downturn is controversial, however, and could make the current cost-of-living crisis even more painful as businesses and households face higher financing costs.

We expect retail traders to remain net long. The current ratio of long to short is 1.70 to 1. This suggests the EUR/USD could continue to fall. The EUR/USD closed at 1.023 or up 0.5%. Our euro outlook against the USD by the end of 2022 is 1.01 while against MYR is 4.46.

Source: AmInvest Research - 22 Jul 2022