ECB hikes rates as expected and Trump signals peace deal near
The ECB raised interest rates by 25bps, taking the deposit rate to 2.25%. The euro was steady in the aftermath of the meeting, as this move was widely expected and the press conference and staff projections show the bank remains hawkish but, broadly speaking, no more or less than was thought before the meeting. The single currency did lose a little ground to the dollar over the course of the day, moving down towards $1.15, but this downward pressure was likely on the back of what seemed like a worsening situation in the Middle East, as sterling also lost ground to the dollar. However, late on came news that President Trump had cancelled further strikes against Iran and that a peace deal could be signed as early as this weekend with the Strait of Hormuz opening thereafter. That saw the dollar weaken as money moved from it as a safe haven, with the euro rising, once again past $1.1570 and sterling gaining back to $1.34. Meanwhile, EURGBP remained, again, in and around 86.3p. Oil prices fell sharply on the news, as you would expect, with a barrel of Brent back below $90/barrel and at the lowest it has been since late April.
Euro bonds rally despite ECB rate hike. With the ECB rate move already priced in and well telegraphed by markets and no surprises in President Lagarde’s press conference, euro area bonds rallied across the curve with 2-year, 5-year and 10-year bund yields all falling about 4bps and similar falls in most euro area member states’ bonds. US bonds also rallied, as the news of a peace deal in Iran being close sent 10-year treasury yields down almost 10bps back below 4.5% and markets pushed out the likelihood of Fed rate hike this year, with a hike now not fully priced in until early 2027. Equities were already seeing some respite yesterday before the peace deal news broke and that news sent equities even higher. The S&P rose 1.8% for the day, wiping out most of the losses taken over the past two days. Industrial stocks led the rebound and there was an uptick for some under pressure tech stocks such as those in semiconductors and hardware while in other tech areas (software) there was a continued fall. The Eurostoxx saw a smaller gain, up 0.8%, though the Iran news came after the close.
The ECB decision to hike rates by 25bps was unanimous. They are the first major central bank to raise rates since the start of the Iran war and this is the first ECB hike since September 2023. President Lagarde, in her press conference, was hawkish but not overly so with the market still fully pricing in the next rate hike for September and there was no signal from Lagarde that a rate hike in July was likely. President Lagarde said the hike this month was a ‘good decision’ but not a ‘forceful’ one, stressing the hike was not an ‘insurance’ move as some members had suggested but a necessary policy response to a ‘major energy shock’. She said the decision was ‘robust’ across any of the scenarios the ECB had previously detailed, including the milder one where inflation increases were more modest. She said ‘there will be no pre-set rate path’ but the outlook was uncertain with upside risks to inflation.
The ECB staff’s revised projections showed a modest reduction in the growth outlook with GDP predicted to increase by 0.8% this year (from 0.9%) and 1.2% next year (from 1.3%) while HICP inflation is revised more sharply higher, to 3% in 2026 (from 2.6%) and 2.3% in 2027 (from 2.0%). The ECB is seeing inflation broaden through the wider economy from energy but still says long-term inflation expectations support a return to 2% price growth. The economy is weaker with the Iran war weighing on activity with services surveys, in particular, pointing to a slowdown. However, Lagarde said growth is not under significant threat and the underlying euro area economy (removing Ireland due to its sharp drop in Q1) grew by about 1% year-on-year in Q1, positive but admittedly more modest growth.
The UK economy contracted by 0.1% in April according to the monthly GDP release. This is the first monthly contraction in eight months but the 3 month moving figure at 0.7% and year-on-year change at 1.2% remained healthy with the carryover from strong Q1 activity helping. Services was weak, falling 0.2% on the the month with consumer confidence hit by worries over the Iran conflict while manufacturing was strong, up 0.4% month-on-month helping to offset some of the weakness in services. While the usefulness of the monthly data has been questioned by Governor Bailey of the Bank of England given its frequent revision today’s data may be a sign of the underlying softness in the UK economy as a number of forecasters feel the strong Q1 data was a product of some demand being brought forward and that activity would be weaker going forward.
On the agenda today, we have University of Michigan sentiment and BoE inflation expectations. Some central bank speakers are returning, just from the ECB, with Nagel and Rehn due out.