MUFG: The EUR - FJElite

Market attention will now switch to the outlook for ECB policy today ahead of their latest policy update. Ahead of the meeting, the euro has been trading on a weaker footing with EUR/USD moving back towards the lower end of the 1.1400 to 1.1800 range that has been in place since the Middle East conflict started. EUR/USD has declined over the past month mainly driven by building expectations for tighter Fed policy. The 2- year US treasury yield has increased by almost 20 basis points over the past month compared to a more modest increase of around 7 basis points in the euro-zone. It reflects catch for US yields as market participants have become more confident that that Fed will not leave rates on hold during the energy price shock. In contrast, the euro-zone rate market had already moved to price in multiple ECB rate hikes curtailing further upside for yields in the near-term.

The euro-zone rate market is fully pricing in a 25bps rate hike form the ECB today. ECB officials have strongly signalled that they are likely to start hiking rates today supported by another upward revision to the ECB staff’s inflation forecasts. We expect President Lagarde to indicate that the outlook for the euro-zone economy is moving more in line with their adverse scenario which requires measured policy tightening. It fits with our own forecast for the ECB to deliver 50bps of hikes this year. The main focus for market participants will be on the updated policy guidance given that there is currently around a 50:50 probability attached to back-to-back hikes in June and July. The euro could weaken modestly if President Lagarde does not signal that another hike is on the cards as soon as next month. It will be difficult to trigger a hawkish repricing with three rate hikes almost fully priced in for this year.