ECB Preview

The economic situation in Europe is more uncertain than even due to the war in Ukraine and puts a significant roadblock to ECB policy normalization.

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Trying to get back on track

Up until February 23, there was a pretty firm consensus that the ECB would take a hawkish turn to deal with rising inflation. The minutes of the previous meeting and comments from the members suggested that March would be the first step to policy normalization. That is when the Pandemic Emergency Purchasing Program (PEPP) funds would run out.

The theory was that the ECB would simply let the program end instead of "rotating" the policy by increasing the regular asset purchases. However, the consensus starting to form is that the ECB will keep asset purchases at the same level and simply use a different name. Given the immense uncertainty due to the war, the expectation is for the ECB to keep maximum flexibility while not changing the underlying monetary situation.

The coming problem

The ECB's staff projections were completed before the start of the war, so they are likely to be ignored by the market. The problem is that inflation is rising, but the economy isn't growing in tandem. A situation called stagflation, attributed to events the ECB cannot affect with monetary policy.

Without a more hawkish tone from the ECB, the euro is likely to continue to slide, exacerbating the monetary policy challenge. A weaker euro implies higher internal inflation. Meanwhile, investors flock to the relative safety of the dollar, weighing on the EUR/USD.

When will rates lift off?

Given the expectation that the ECB will try to keep as much flexibility as possible, the consensus appears to be that Lagarde will avoid providing any hints about when the next rate hike could be. Current money markets seem to be pointing to a lift-off in December of this year. However, how likely that will turn out to be probably depends most on something we can't predict: the end of the war in Ukraine.

Bullish path questionable

EUR/USD has been on a bear market since last July. Instead of showing some signs of a pullback, the 200 and 50-day gap widens. A near 2-year low at $1.08 support was reached only this week and offered a relief rally, but it's unlikely to move past $1.1125. The break of the January 28 swing low might be a turning point.
Currently below $1.10, the eurodollar remains under pressure. If bears take over the reins again, prices could find support around $1.09, and then it's a one-way trip to $1.08. If momentum increases, the $1.07275 and $1.06338 come into play. Inversely, a break of the round $1.10 would offer extra relief to $1.1063, and if $1.1124 gives in, bulls could face the next hurdle closer to $1.12.

Source: TradingView

Key takeaways

ECB's plans to normalize have been overshadowed by the war, and policymakers are unlikely to let asset purchases run out despite inflation rising. This would be a market negative for the euro unless Lagarde hints at a hike sooner than December or announces the end of PEPP without "rotating" policy.