EUR & ECB crib sheet: Hawks can’t lend their wings to the euro

This has become a consensus call in recent weeks, and markets are fully pricing in such a move. This means that – barring a surprise on the size of the hike – the market reaction will depend on the ECB’s stance on:

• Further rate rises: any tweaks to the meeting-by-meeting data-dependent approach and/or references to the terminal rate
• Changes in the inflation and growth outlook
• Discussion over quantitative tightening

In our ECB preview, we highlight what we expect to hear on those topics this week. Here you can see where we're coming from; it's our usual pre-meeting scenario analysis, where we look at implications for EUR/USD and the rates market to those different potential outcomes.

As shown above, we see limited upside risks for EUR/USD in the aftermath of the ECB announcement. This is mainly due to the weakened correlation between short-term rates and currency dynamics in the eurozone. This means that additional tightening being priced into the EUR curve on the back of a hawkish statement still looks unlikely to offer a sizeable, and above all, sustainable support to the euro.

This was indeed the case in the past few meetings, where the ECB consistently surprised on the hawkish side but that did not avert a euro depreciation. A tightening-based FX protest (against the inflationary weak euro) is simply not working in the current market environment.

In line with our expectations of a stronger dollar, as the Fed keeps tightening policy and keeps risk sentiment weak into the new year, we expect a drop below 0.9500 in EUR/USD by the end of this quarter.