Why Euro Tanked After ECB Rate Decision

By Kathy Lien

The euro staged a dramatic intraday reversal today on the back of the European Central Bank’s monetary policy announcement. Having jumped as high as 1.1120 after the ECB, EUR/USD ended the New York session below 1.10. The central bank surprised the market with the decision to phase out its bond-buying program in the third quarter, which is earlier than its prior guidance. Back in December, the ECB said it would continue buying bonds through at least October. This paves the way for an interest rate hike at the end of the year. According to ECB President Christine Lagarde, “Any adjustment to the key ECB interest rates will take place some time after the end of our net purchases under the APP (Asset Purchase Program) and will be gradual.”

Normally, the possibility of earlier rate hikes should be positive for the currency, but the sell-off in the euro tells us that investors are worried about stagflation. By ending asset purchases sooner than anticipated, the central bank is taking the dangerous step of tightening in the face of slowing growth. Even Lagarde said the risks to growth are to the downside. Rising borrowing costs and record gas prices compounds the problem for Europe just as Russia intensifies its attack on Ukraine. High-level talks have broken down, dampening hopes for a diplomatic resolution.

Investors also sold euros on the back of strong U.S. inflation data. Consumer prices grew at its highest pace in 40 years with year-over-year growth reaching 7.9%. The Federal Reserve meets next week and there’s no doubt that it will begin raising interest rates for the first time since 2018. Although slower growth is also a risk for the U.S., as the world’s top oil producer, it is far less vulnerable to Russian sanctions than Europe. The household savings rate is also at a record high and this financial cushion eases the pain of rising prices for Americans, making it easier for the Fed to hike. On a technical basis, it is no coincidence that today’s rally stopped almost to the pip of the Jan. 28 swing low of 1.1120.

While Europe will be hurt the hardest by Russia’s invasion, if there’s any hint of a diplomatic resolution, traders can expect a swift and aggressive short covering rally in the euro.

Looking ahead, there are a flurry of UK economic reports scheduled for release tomorrow along with Canada’s jobs report and the University of Michigan consumer sentiment index. Based on the rise in the employment component of IVEY PMI, job growth in Canada should be strong. However, sentiment in the U.S. could take a steep tumble as rising gas prices, falling equity values and the Russian invasion spooks consumers.