GBP/EUR Rate Retreats Below 1.17 on ECB Hike and Hint of More to Come

• Deposit facility rate hiked 25bp to 3.50%
• Main refinancing rate hiked 25bp to 4.00%
• Marginal lending facility rate hiked 25bp to 4.25%

Above: File image of Christine Lagarde. Image by Dominique HOMMEL. © European Union - Source: EP

Euro exchange rates were higher after the European Central Bank (ECB) raised interest rates by 25 basis points and gave no indication it was considering an end to the interest rate hiking cycle.

All three of the ECB's main interest rates were lifted after the Bank said in a statement inflation "is projected to remain too high for too long".

Indeed, new forecasts from ECB economists show inflation won't fall back to the 2.0% target within the next two years.

Headline inflation forecasts were revised higher to an average of 5.4% in 2023, 3.0% in 2024 and 2.2% in 2025. Core inflation is now seen reaching 5.1% in 2023, 3.0% in 2024 and 2.3% in 2025.

"Despite good arguments against further rate hikes, the ECB simply cannot afford to be wrong on inflation. The Bank wants and has to be sure that it has slayed the inflation dragon before considering a policy change. This is why they are putting more than usual emphasis on actual inflation developments," says Carsten Brzeski, Global Head of Macro at ING Bank.

The messages coming from the ECB offered Eurozone bond yields and the Euro some support: the Euro to Pound exchange rate rose to 0.8576 in the minutes following the decision, taking the day's advance to 0.30% (Pound to Euro rate down to 1.1660).

The Euro to Dollar rate extended its daily gain to 0.25% at 1.0850.

In the press conference, ECB President Christine Lagarde said her team "is not satisfied with the inflation outlook".

She explained wage pressures are becoming an increasingly important source of inflation to consider at a time where core inflation remains sticky.

The ECB acknowledges the economic growth outlook has deteriorated and staff lowered GDP forecasts for this year and next year. They now expect the economy to grow by 0.9% in 2023, 1.5% in 2024 and 1.6% in 2025.

"It looks as if the ECB remains one of the last growth optimists standing, expecting eurozone growth to return to potential before year-end. This keeps the door for further rate hikes wide open," says Brzeski.

The ECB also reckons its rate hikes are working: "The Governing Council’s past rate increases are being transmitted forcefully to financing conditions and are gradually having an impact across the economy."

The ECB meanwhile said it would finally close the door on its quantitative easing programme (Asset Purchase Programme) from July, a decision that will also potentially support Eurozone bond yields going forward.

The Pound has been in the ascendency against the Euro as investors reckon there are more hikes still to come from the Bank of England than the ECB.

But the open-ended nature of the ECB's guidance serves as a reminder that there remains the prospect of the peak in the expected ECB rate being higher than previously assumed.

This can support the Euro and counter the Pound's ongoing trend of appreciation, to an extent.