Euro Rally Could "Extend in Coming Days" - Analysts React to Reports of Shift in ECB Interest Rate Policy

- ECB look eager to crack on with raising interest rates

- Euro could rise more aggressively later in 2018

- GBP/EUR exchange rate's Brexit-related gains could be capped by ECB

European Central Bank policy changes and risks to the Euro

The European Central Bank has shot back into the spotlight for Euro traders over the course of the past 24 hours amidst reports policy-setters are openly discussing how to go about raising interest rate rises.

Currently, markets are prepared for the first interest rate rise in 2019, but there are signs that the ECB might have to toy with the idea of raising rates 1) Sooner and 2) More aggressively than currently expected.

And, higher rates delivered faster make for a stronger Euro, something those with Euro-based international payments need to seriously consider.

Sparking interest in the future of Eurozone interest rates and the exchange rate were reports ECB policymakers are now beginning to shift their debate to the expected path of rate hikes once their quantitative easing programme has ended.

Most now expect the quantitative easing programme to end in 2018, which should open the door to rate rises in 2019.

According to a Reuters report, ECB policymakers are now debating how to phase out their 'unconventional tools' - i.e. quantitative easing - and normalise policy in a time of robust growth but weak inflation.

'Normalisation' is short-hand for raising interest rates to more natural levels.  

One source was quoted as saying that “the only point is extending the quantitative easing programme would be to push out rate hike expectations and anchor the yield curve, but that can be done with other tools, like a more precise forward guidance or more long-term financing operations”.

As a result, the source has not seen a “serious case for another extension” of the quantitative easing programme.

The Euro has risen steadily over the past year as markets anticipate the end of the quantitative easing programme. But the threat of extending the programme beyond 2018 has long ensured the currency's run higher has ultimately been kept under control.

According to the same report, ECB policymakers are reportedly “comfortable” with current market expectations for the first rate hike to be implemented by mid-2019, but there are concerns about just how rapidly future interest rates rise once the cycle starts.

All this matters for the Euro as a faster pace of rate rises could unleash more gains.  

"At the current juncture, the market appears well priced for ECB rate hike expectations in 2019 which has been helping to dampen the Euro’s upward momentum in the near-term," says Lee Hardman, currency analyst with MUFG.

But, "the Euro could strengthen more sharply later this year if the ECB fails to dampen rate hike expectations once they bring an end to their QE programme," warns the analyst.

Valtteri Ahti, Chief Strategist with Danske Bank, notes the Euro exchange rate complex was "generally bid yesterday after the ECB sources story that focus is shifting to controlling rate expectations as QE is set to end, and that the ECB is satisfied with current market pricing".

"The latter is a hawkish signal, in our view, given what we see as somewhat aggressive pricing of a first hike at present. We would not be surprised to see the EUR rally extend in coming days," says Ahti.

The Euro is currently priced at discounted levels against both the Pound and Dollar when compared to February when it was pushing on the upper limits of recent ranges.

The decline in EUR/USD from a high at 1.2556 towards current levels at 1.2341 came following the ECB's March policy event in which policy-makers communicated they were in no rush to abandon their quantitative easing programme.

The EUR/GBP exchange rate has declined back down to 0.8776, having been as high as 0.8968 earlier this month, in part largely thanks to the more constructive narrative around Brexit that has occurred.

But here too, there is a risk the Euro makes a comeback on ECB sentiment.

Economist Chiara Silvestre with UniCredit Bank in Milan confirms the announcement on a Brexit transition is "good news that should support the currency over the medium term" but reminds clients that the Euro is also likely to remain supported by the positive economic developments in the Eurozone and the resultant ECB policy expectations they generate.

As a result, the Pound-to-Euro exchange rate is expected by Silvestre to remain "relatively stable" and it "looks unlikely to break out of its established range which is identified as being between 1.15 and 1.11.

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