- EUR under pressure ahead of ECB rate decision
- ECB was expected to hike 50bp on Thursday
- Move now in doubt following bank share selloffs
- EUR could fall further if ECB holds rates
- Or signals uncertainty as to future moves
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The Euro faces another potential day of elevated volatility as the European Central Bank (ECB) is confronted by signs of instability in European banks.
At 13:15 GMT all eyes will turn to the ECB and President Christine Lagarde amidst concerns for the stability of the Eurozone's financial sector in an environment of rapidly rising interest rates.
The immediate rule of thumb is that any added caution could weigh on the Euro exchange rate complex and see recent losses deepen.
The Pound to Euro exchange rate (GBP/EUR) rallied to a high of 1.1470 on Wednesday after European bank shares slumped amidst fears for the health of 'systemically important' lender Credit Suisse.
Credit Suisse has been under pressure for some time but slumped by almost 60% at one stage on Wednesday after a key investor warned it would not make available any more capital injections to shore up the lender.
The ECB asked Eurozone lenders to divulge their exposure to the Swiss bank, amidst signs it was considering 'worst case' scenarios.
"If Credit Suisse were to run into serious existential trouble, we are in a whole other world of pain. It really is too big to fail. I fail to see how the ECB can go ahead with 50bps tomorrow in this febrile kind of environment," says Neil Wilson, Chief Market Analyst at Finalto.
The key question for the ECB - and by extension currency markets - is whether it feels it can proceed with its well-telegraphed 50 basis point hike given higher rates could lead to further stress for Eurozone banks.
"The EUR has been impacted despite reports that the ECB will stay the course an announced the 50 bps move that its has already indicated," says Jane Foley, Senior FX Strategist at Rabobank.
The Eurozone's central bank has said it would hike by 50bp owing to signs of elevated core inflation in the Eurozone and that further such hikes were likely.
A decision to keep rates unchanged on account of recent developments would therefore come as a surprise that could pressure the Euro lower.
But even a 50bp hike accompanied by guidance that more hikes are to come is also no guarantee the Euro will avoid further weakness.
Above: The Euro was the second-worst G10 performer as fears for Eurozone bank stocks increased.
"The market is aware that the ECB is in a difficult position. Hiking rates by 50 bps against the backdrop of a jittery market and a tightening of financial conditions may fail to lift the EUR if investors assume that the central bank is deepening the risk of a downturn," says Foley.
The fall in Eurozone government bond yields on Wednesday suggests investors no longer see a 50bp hike as a sure bet and that the coming peak in Eurozone interest rates will now be materially lower than previously predicted.
This in turn acts as a drag on the Euro:
Above: EUR/GBP tracks Italian two-year bond yields lower. (Consider setting a free FX rate alert here to better time your payment requirements.)
"From here, the best-case scenario is that jitters across the wider financial sector in Europe settle. This would allow the market to return its focus to economic fundamentals and specifically the risks around inflation. This would make it easier for the market to absorb a 50-bps rate hike from the ECB tomorrow and for EUR/USD to rally back above 1.06," says Foley.
"In almost any other scenario, the EUR is likely to stay vulnerable," she adds.
What has happened to the Euro echoes the fate suffered by the U.S. Dollar earlier in the week when U.S. bond yields retreated as investors erased bets for a 50bp hike at the Federal Reserve next week.
Ahead of the recent banking sector jitters the Bank of England was seen as the least aggressive of the three central banks on the interest rate policy front.
A 'no change' at the March 23 policy event would therefore not carry much of a surprise factor for the Pound.
This explains why the Pound-Euro exchange rate rallied on signs of Eurozone bank stock stresses; simply put the Euro had greater rate hike expectations embedded in its value.
But the Pound's relative stability cannot be guaranteed: the currency came under significant pressure against both the Euro and U.S. Dollar during the 2008 financial crisis, confirming it to be at risk of a more significant financial implosion.
For now, economists say we are not witnessing a systemically significant moment for the financial sector.
"The market reaction in the short term looks to be overdone," says Skylar Montgomery at TS Lombard. "There is no systemic crisis."