Prior to the recent ECB meeting, there were expectations of a 25bps rate hike. Market focus centered on the forward guidance, particularly the future trajectory of rates. In summary, while inflation expectations increased and GDP projections were lowered, the ECB intends to maintain a flexible and data-driven approach moving forward.

Flexibility in ECB’s strategy

Christine Lagarde signaled that a rate hike in July was “likely”. However, the ECB is closely monitoring key economic indicators to inform its decisions. Specifically, core inflation and the tight labor market are of interest. Core inflation projections were revised significantly higher, with 5.1% for 2023 (up from 4.6%) and 3.0% for 2024 (up from 2.5%). The latest eurozone core inflation reading was 5.3% y/y following the ECB meeting. ECB’s Wunsch mentioned the possibility of a hike in September if core inflation remains around 5%, so that provides a benchmark for his thinking.

German and US bond yield spread

Following the more data-dependent approaches of both the Fed and the ECB in their respective meetings last week, the bond yield spread experienced a rapid increase. Why? Bond traders perceive the Fed reaching its rate peak before the ECB. Therefore, to gauge the direction of EURUSD, it is advisable to monitor the bond yield spread, available on trade view by adding DE10Y-US10Y to the instrument panel.

EURUSD yield and expectations

According to Financial Source’s interest tracker, short-term interest rate markets anticipate only one more ECB rate hike, with a terminal rate of 3.79%. The question remains whether the ECB will hike again in September if it proceeds with a hike in July. To find the answer, keep a close watch on incoming labor and inflation data.