The minutes of the December policy meeting of the ECB released today reinforced the hawkish policy stance that the ECB tried to communicate during and after the meeting: the Bank is far from completing the tightening cycle and more rate hikes are necessary.

The key takeaways of the December minutes were that “the direction of monetary policy must be resolutely tightened and that the current configuration of interest rates and expectations incorporated in asset prices has not been sufficiently restrictive to bring inflation back to the target level in a timely manner.” Several ECB members have called for a 75bp rate hike (instead of the agreed 50 bp), and also opted for a fast pace of reinvestment of matured bonds under the APP.

Ahead of the forthcoming ECB meetings, it is becoming clear that the central bank intends to deliver more rate hikes. Basically, the message creates a benign environment for more Euro gains against its peers, including USD.

It should be understood though that the softer inflation that we’ve seen recently in the euro area has little to do with the removal of the ECB stimulus. The spike in inflation was mainly the aftermath of higher energy prices, and the recent drop correlates with lower energy prices, especially gas prices:

Therefore, when predicting what the ECB will do next, it makes sense to analyze not what the ECB should do, but what the bank says it will do. Hawkishness is no longer a characteristic of just a few members of the ECB. It has become mainstream.

Another 50bp rate hike at the February meeting two weeks later is apparently priced in, and another 50 bp rate hike at the March meeting even looks very likely. As long as core inflation remains consistently high and core inflation forecasts remain above 2%, the ECB will continue to raise rates. To some extent, we are seeing a mirror image of the ECB to 2019. At the time, the Bank was clearly easing and pursuing disinflation by all means possible, even though the root causes of disinflation lay outside the ECB’s purview. Now the ECB has a clear desire to tighten and is chasing inflation, which may also have its root cause in something the ECB can’t handle. However, it looks like the current generation of ECB policymakers will only let them go when they are fully convinced that inflation is no longer a problem. As a result, a modest improvement in growth prospects in the euro area, as well as the abundant fiscal stimulus, gave the Bank even more reason to continue its hawkish mission. With all this in mind, the ECB is unlikely to cut interest rates again. Current market expectations for ECB rate cuts in 2024 are premature. If anything, these expectations, reflected in the cut in long-term interest rates, are an additional argument for the ECB to remain hawkish. The ECB’s aggressiveness in December was also the result of the central bank’s view that market pricing lagged the pace of actual policy tightening. Today’s comments by Christine Lagarde and Klaas Noth once again illustrate the ECB’s determination to go all the way.

EURUSD continues to consolidate near 1.08 with no obvious attempts to test the levels below. Market participants are trying to assess the risk of a slowdown in the Fed’s tightening to 25 bp February, as well as softening the rhetoric regarding inflation. US stocks fell, reacting to the slew of weak eco updates on the US economy. The weakness of the dollar now depends on two factors: the market’s assessment that weakening activity in the US will infect other economies (which will increase demand for the dollar as a defensive asset) and the Fed’s reaction to a series of soft data for December. If the Fed begins to worry about a recession and changes the policy vector to a dovish one, we can expect a rebound in risk asset markets and a continuation of the EURUSD rally. Moderately hawkish comments may allow the dollar to bounce and cause a correction in EURUSD to 1.07 – 1.0650: