A rate hike in July is now more likely, stabilizing the euro in the short term
The likely tightening of policy rates in July should not increase financing costs significantly for MNCs’ local partners. However, a relatively weak euro will continue to add to cost pressures for businesses in both 2022 and 2023.
Overview
• Eurozone inflation accelerated to 7.5% YOY in April from 7.4% YOY in March.
• The USD to EUR rate reached 0.96 in mid-May, prompting fears that the EUR will reach parity with the USD, which will further exacerbate inflationary pressures.
• European Central Bank (ECB) president Christine Lagarde has signaled a gradual tightening of monetary policy in the coming month, with the ECB likely to abandon its long-standing negative deposit rates.
Our View
Lagarde’s comments signal that monetary tightening will occur earlier than expected. Our original expectation was for a 25-basis-point hike in September. Given the pressures on the EUR, mounting inflation, and the shift in the ECB’s stance, a 50-basis-point rate hike in July is much more likely, which will bring the deposit and key policy rates to 0.0% and 0.5%, respectively. The move should stabilize the EUR in the short term. However, weakening economic growth in WEUR will prompt additional depreciation pressure on the currency and likely require another small hike in November 2022, which will bring the key policy rate to 0.75%. The latter, combined with the ongoing winding down of the ECB’s asset purchasing power, should prevent a further depreciation of the EUR, and while we expect it to reach a rate of 0.97 to the USD in October/November 2022, it should avoid a full parity with the dollar. Persisting inflationary pressure in 2022, a slow recovery, and a large spread between the ECB’s and the Fed’s policy rate will limit the space for an EUR appreciation in 2023, and we expect the average rate for the USD:EUR pair to be in the range of 0.93–0.95 for the whole year.
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