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Βy Shavasb Bohdjalian
On Thursday, the European Central Bank looks all but certain to become the first major central bank to increase interest rates by at least 25 basis points as it tries to tame rising inflation.
The ECB, the Bank of Japan and the Bank of England all conclude policy-setting meetings on Thursday but they will probably reach three different decisions.
The BOJ, which already cut rates to near zero, will probably downgrade its economic assessment and may consider finding more ways to ease as a buffer against the earthquake's economic damage. Most economists polled by Reuters think Japan is heading for a brief recession before rebuilding efforts revive growth.
The BoE is caught between the crosswinds of high inflation and weak economic growth, which means that in most likelihood, rates will remain on hold.
The ECB on the other hand is widely expected by economists polled by Reuters to lift interest rates by 25 basis points to 1.25% in an attempt to fight inflation, which according to the latest data remains stubbornly above the ECB’s 2% target.
Since ECB President warned the markets that a rate hike would be delivered at the April 7 meeting, the actual rate hike is not the big story but the accompanying statement and the comments that Jean Claude Trichet will make during the press conference that usually follows the ECB meetings.
If Trichet says that the ECB will remain vigilant but will wait for further data before taking its next action, then this could lead market participants to expect that the ECB is in no hurry to lift rates, which means the market may ignore the actual rate hike in a classic “buy the rumour, sell the fact” scenario.
Such a theme will certainly hurt the euro and force it lower. Euro rate expectations will also be scaled lower, since a number of economists and analysts have started pricing in at least another 2 rate increases of 25 basis points each before the year is over.
On the other hand, if Trichet makes a statement preparing the markets for additional rate increases without giving a damn about the peripheral, then the market will most probably price in quicker rate increases and immediately break the 1.4280 most recent high and push the euro towards 1.45 against the dollar.
It is obvious that higher ECB rates could cause problems for countries like Greece, Ireland and Portugal that are struggling to solve sovereign debt crises. And since retail sales in Germany have started moving lower, the ifo sentiment index is also pointing lower and with China (Germany’s biggest market cooling off), there is adequate ground for the ECB to behave rationally and not over-emphasise rising inflation which in any event is likely to edge lower from June onwards.
In my opinion, investors are pricing in more tightening than the ECB will actually deliver, which is why I believe come Thursday, we are going to see a classic “buy the rumour, sell the fact” scenario as the market scales down its rate hike expectations.
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(Shavasb Bohdjalian is an approved Investment Advisor and CEO of Eurivex Ltd., a Cyprus Investment Firm, authorized and regulated by CySEC, license #114/10. The views expressed above are personal and do not bind the company and are subject to change without notice. Investing in markets and trading on leverage is highly risky and it may not be suitable to all investors since it carries a high degree of risk and you can lose more than your initial investment)
