The euro rose above $1 in morning trade in New York on Friday after Reuters reported that the European Central Bank might discuss raising its key rates by as much as 75 basis points at their next meeting in September.
The ECB had guided at the last meeting that another increase was likely warranted. Still, subsequent ECB governing council comments indicated that the choice would be between hikes of 25 or 50 basis points. The ECB raised its deposit rate to 0% in July, ending eight years of negative interest rates.
“Inflation is more and more broad, and second-round effects are clear,”
By 10:00 ET, the euro was at $1.0032, also lifted by tentative signs of a weakening inflation dynamic in the U.S., where a key gauge of consumer prices – the price index for personal consumer expenditures – fell 0.1% in July, bringing the 12-month rate of inflation down from 6.8% to 6.3%. The numbers nudged market sentiment toward expecting a slight relaxation in the pace of interest rate hikes by the Federal Reserve.
Frederik Ducrozet, an analyst with Pictet Asset Management, described the story as a “trial balloon” launched by the bank’s hawks. The accounts of the ECB’s last meeting, published on Thursday, suggested that many were unhappy with what has so far been a slow response by the Frankfurt-based central bank to the worst inflation episode in 40 years.
Even so, Ducrozet noted that a 75 basis point hike is unlikely.
“Recession risks are rising by the day,” he noted via Twitter, adding that “wage growth remains subdued.”
The report also had a big impact on European government bond markets. The benchmark German 10-Year bond yield rose by 10 basis points to hit a two-month high of 1.43% before retreating slightly. The effect on financially weaker Eurozone members was even bigger: Italy’s 10-year yield rose by 19 basis points to 3.75, a one-month high. The yields on Spanish and Portugal benchmarks rose by some 10-11 basis points.
Changes in ECB rates tend to have a bigger impact on the so-called peripheral states of the Eurozone, which have historically had larger debt burdens and have consequently been more sensitive to changes in financing conditions.
The ECB said in July that it would press ahead with a new tool to stop unwarranted volatility in bond markets. Until that tool is operational, it uses the leeway allowed by its old quantitative easing program to stop yield spreads from widening too much. As such, when it reinvests the proceeds of maturing bonds in its portfolio, it is reallocating funds away from ‘core’ markets such as Germany and the Netherlands to markets such as Italy.