15.12.202223:52 Forex Analysis & Reviews: ECB raised the rate +0.5% and promised to raise more

EURUSD after the European Central Bank's decision

The Governing Council decided to raise the ECB's three key interest rates by 50 basis points and, based on a significant upward revision to the inflation forecast, expects them to rise further. Specifically, the Governing Council believes that interest rates will still need to rise significantly at a sustained pace to reach levels that are sufficiently restrictive to ensure a timely return to the medium-term inflation target of 2%. Keeping interest rates at restrictive levels over time will reduce inflation by restraining demand and will also protect against the risk of a permanent rise in inflation expectations. Future Governing Council decisions on policy rates will continue to be data-driven and follow the approach taken at each meeting.

The ECB's key interest rates are the Governing Council's main tool for setting the course of monetary policy. The Governing Council also discussed the principles for normalizing the Eurosystem's monetary policy securities holdings. From the beginning of March 2023, the asset purchase program (APP) portfolio will decrease at a measured and predictable pace, the Eurosystem not reinvesting all principal repayments of maturing securities. The decline will amount to €15 billion per month on average until the end of the second quarter of 2023, and its subsequent pace will be determined over time.

At its February meeting, the board will announce the detailed parameters of the reduction in APP holdings. The Governing Council will regularly reassess the pace of the APP portfolio reduction to ensure that it remains consistent with the overall strategy and course of monetary policy, to preserve market functioning, and to maintain firm control over short-term money market conditions. By the end of 2023, the board will also review its operational framework for steering short-term interest rates, which will provide information on the outcome of the balance sheet normalization process.

The Governing Council decided to raise interest rates on Thursday, and expects to raise them significantly further because inflation remains too high and is projected to remain above target for too long. According to Eurostat's flash estimate, inflation was 10.0% in November, slightly lower than the 10.6% recorded in October. The decline was mainly due to lower energy price inflation. Food price inflation and underlying price pressures in the economy have strengthened and will persist for some time. Amid exceptional uncertainty, Eurosystem staff have significantly revised up their inflation forecasts. They now see average inflation reaching 8.4% in 2022 and before falling to 6.3% in 2023, with inflation expected to fall markedly over the year. Inflation is then projected to average 3.4% in 2024 and 2.3% in 2025. Inflation excluding energy and food is projected to be 3.9% on average in 2022 and rise to 4.2% in 2023, before falling to 2.8% in 2024 and 2.4% in 2025.

The eurozone economy may contract in the current quarter and next quarter due to the energy crisis, high uncertainty, weakening global economic activity and tighter financing conditions. According to the latest forecast by Eurosystem staff, the recession will be relatively short-lived and shallow. Nevertheless, growth next year is expected to be slower and has been revised down significantly from previous forecasts. Growth is projected to rebound in the near term as the current headwinds weaken. Overall, Eurosystem staff expect annual average real GDP growth to slow down markedly, from 3.4% in 2022, 0.5% in 2023, and then to rebound to 1.9% in 2024, and 1.8% in 2025.