Market Extra: The euro touched a 2-year low because the ECB is moving at a ‘snail’s pace’ to normalize rates

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The euro slumped to a two-year low versus the U.S. dollar Thursday after the European Central Bank indicated it wasn’t ready to accelerate its plan to halt its asset purchases and begin lifting interest rates in response to surging inflation complicated by Russia’s invasion of Ukraine.

The shared currency’s weakness came after the ECB Governing Council, in its policy statement, affirmed that it would end its bond-buying Asset Purchase Program in the third quarter, disappointing investors who had looked for a signal that it would bring purchases to a halt more quickly and perhaps raise interest rates as early as July. The ECB said it would lift interest rates “some time after” it had halted net asset purchases.

“In the current conditions of high uncertainty, we will maintain optionality, gradualism and flexibility in the conduct of monetary policy,” ECB President Christine Lagarde said at a news conference she attended remotely after contracting COVID-19 earlier this month.

Lagarde said “some time after” meant that rates could rise “weeks” or “months” after purchases end.

The euro
EURUSD,
-0.67%

was down 0.6% versus the U.S. dollar at $1.0825 after dipping as far as $1.0726, its lowest since April 23, 2020, according to FactSet. The euro has dropped nearly 10% versus the dollar so far in 2022, helping to fuel a rise by the widely tracked ICE U.S. Dollar Index
DXY,
+0.56%

to a two-year high. The DXY measures the dollar against basket of six major rivals, weighted heavily toward the euro.

The currency came off its low after Reuters, citing sources close to the matter, reported that policy makers could still move to lift rates in July.

The ECB next meets in June, where it’s expected to offer a more detailed roadmap. The June meeting will see updated staff projections for eurozone growth and inflation.

Investors should remember that given high uncertainty, the ECB will “always try to link crucial decisions to new macro projections,” said Carsten Brzeski, global head of macro at ING, in a note.

With that in mind, ING expects the ECB to stop net asset purchases in July and start hiking interest rates in September, Brzeski said.

That means the ECB “will definitely not get ahead of the central banks’ pack any time soon in terms of policy normalization,” he wrote. “It will be normalization at a snail’s pace.”

The path to a rate increase in September, however, is complicated by the ECB’s timetable that phases out its quantitative easing program over the course of the third quarter rather than a sudden stop in July, argued Claus Vistesen, chief eurozone economist at Pantheon Macroeconomics.

“This, in turn, would make it difficult for the central bank to raise rates in September, which is currently our baseline. That said, the central bank is clearly keeping all options open here,” he said, in a note.

Meanwhile, the Federal Reserve has ended its program of asset purchases and has already delivered a quarter percentage point benchmark interest rate increase. Officials have signaled a likely half-point rate increase at the next Fed meeting in May, which may also see the policy makers kick off an aggressive plan to begin shrinking the central bank’s balance sheet.

The Bank of England has returned its borrowing rate back to its pre-pandemic level. The ECB’s deposit rate remains at negative 0.5%, while its refi rate stands at 0%.

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