(Kitco News, Thurs. July 21st, 2022) – The growing threat of inflation prompted the European Central Bank to surprise markets by raising interest rates across the board by 50 basis points, providing the euro with new momentum against the U.S. dollar and, in turn, pushing gold prices back above $1,700 an ounce.
Along with rising price pressures, ECB President Christine Lagarde also noted growing economic risks; however, she added that the central bank does not expect to see the European economy fall into a recession.
“The latest data indicate a slowdown in growth, clouding the outlook for the second half of 2022 and beyond. At the same time, this slowdown is being cushioned by a number of supportive factors,” Lagarde said in her opening remarks. “Economic activity continues to benefit from the reopening of the economy, a strong labour market and fiscal policy support. Consumption is being supported by the savings that households built up during the pandemic and by a strong labour market.”
Although the European economy faces growing downside risks, the ECB sees inflation as the biggest threat on the horizon.
“The risks to the inflation outlook continue to be on the upside and have intensified, particularly in the short term. The risks to the medium-term inflation outlook include a durable worsening of the production capacity of our economy, persistently high energy and food prices, inflation expectations rising above our target and higher than anticipated wage rises,” Lagarde said.
Although the ECB expects to continue to raise interest rates through the rest of the year, markets saw little guidance on the steepness of the tightening path.
Lagarde said that the central bank would not provide any forward guidance on rate hikes and added that she didn’t know where the neutral rate would be.
“At our upcoming meetings, further normalisation of interest rates will be appropriate. Our future policy rate path will continue to be data-dependent and will help us deliver on our 2% inflation target over the medium term,” she said.
Along with raising interest rates, the ECB also approved a new policy tool, the Transmission Protection Instrument (TPI).
While the TPI has been launched to reduce fragmentation risks in the eurozone, markets have not received a lot of information on how it will be implemented.
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“The TPI will ensure that our monetary policy stance is transmitted smoothly across all euro area countries. The singleness of our monetary policy is a precondition for the ECB to be able to deliver on its price stability mandate,” Lagarde said.
According to some market analysts, the ECB’s aggressive move should help improve sentiment in the gold market as U.S. dollar gains could be capped.
The U.S. dollar has been on an unstoppable rally, recently hitting a 20-year high and touching parity with the euro. Analysts have said that the U.S. dollar’s run is partly because of the significant monetary policy gap between the Federal Reserve and the ECB.
This is the first time the ECB has raised interest rates in over a decade. Meanwhile, the Federal Reserve has raised interest rates three times this year, taking the Fed Funds rate to a target between 1.50% and 1.75%.
The Federal Reserve is expected to raise interest rates another 75 basis points later this month.
Looking ahead, some analysts see limited scope for the euro as the interest rate gap remains particularly wide.
Currency analysts at TD Securities said that they see the euro hitting resistance between 1.03 and 1.04 against the U.S. dollar in the near-term.
“No matter how you slice and dice it, the eurozone is in a very difficult spot. The global CB community has adopted the front-loading mentality, but many, like the ECB, are facing a Ricardian equivalence dilemma – more policy aggression now is just borrowing tightening from the future. We still contend that EUR is buy the rumor/sell the fact, because there is little the ECB can do to avoid an energy crisis and an implosion of the current account,” the analysts said in a note.
With limited gains expected for the euro, some analysts have said that gold prices could continue to struggle.
“When all is said and done, we believe the U.S. economy will prove to be more resilient than the rest of the world and so we look for continued dollar gains,” said currency analysts at Brown Brothers Harriman.
Posted by:
Jack Dempsey, President
401 Hokd Consultants LLC
jdemp2003@gmail.com