ECB and BOE Expected to Hold to Assess War Impact

Markets have been volatile, but projections now are for the two big central banks in Europe to keep rates unchanged as they balance the impact of war-driven inflation against the economic outlook.

What Markets Are Looking For

• The ECB and BOE are expected to hold as they wait to see the impact of the war in the Middle East on inflation and the economy.
• Markets are pricing in more action from central banks, which have been criticised for slow responses to inflationary pressures since the war in Ukraine sent crude soaring.
• The outlook for the currency pair could depend on which central bank is more worried about inflation.

ECB's "Good Place" Under Threat

Market expectations regarding central bank policy amid the war in the Middle East have varied wildly. A week into the war, when Brent threatened to break $120 per barrel, the market was pricing in as much as 50 bps of ECB tightening this year. As the price of crude fluctuated, so did expectations for the ECB, with the economists polled by Reuters completely pricing out rate hikes just a few days ago. Now that crude is back in the triple digits, futures are once again pricing in a rate hike by July and a 55% chance of a second hike by the end of 2026.

Europe's main central bank has to decide policy without any data on the current situation, as key figures such as CPI, employment, and even March PMI readings won't be available until after the meeting. This has left analysts anticipating that the ECB and BOE will try to buy time, keeping policy steady and warning of potential risks. It is a particularly fraught time for central bankers, who came under intense criticism the last time crude spiked for saying that inflation was "temporary" and being slow to tighten.

The Bank for International Settlements (BIS – the "central bank to central banks") is urging calm on monetary policy, saying the war is a textbook case of when to "look through" a supply shock if it proves temporary.

Up until now, the ECB has enjoyed inflation being in "a good place", as President Christine Lagarde likes to say, but if the war lasts too long, those prices might rise, and so will rates. The question for traders is whether the ECB will address the issue.

Currencies Adjust as BOE, ECB Are Expected To Hold

With no indication of how long the war will last, how severe the supply disruption will be, or how much impact it will have on economies, central banks are on hold and playing for time. The BOE was expected to cut rates on Thursday amid a weakening UK labour market. The vote was expected to be highly divided, with BOE Governor Andrew Bailey casting the tie-breaking ballot. But the threat of higher inflation is expected to convince him to vote to hold. What could pose a problem for money markets is that the vote split is often seen as an indicator of where policy is likely to go. But many who voted to cut in the past might temporarily switch to hold because they want more data, not because they have suddenly joined the hawkish side. This could leave the pound stronger in the aftermath.

Previously, the ECB was expected to hold while the BOE cut, but now both are seen leaving policy unchanged, and the pound has gained against the euro. But the currency pair could fluctuate depending on the rhetoric of central bank heads as they address the potential for higher inflation from rising crude prices. The one who expresses more concern about inflation could see its currency strengthen in the short term as markets price in higher interest rates. However, any increase could fade relatively quickly.

EURGBP Forms Double Bottom Ahead of ECB-BOE?

EURGBP might have just completed a double bottom near 0.8620, but the neckline confirmation is as far as the peak of 0.8790. With the VWAP lines flattening out ahead of the two bank decisions, a breakout could help confirm (longer-term) or invalidate (short-term) the formation. Higher prices outside the upper VWAP at 0.8647 would expose 0.8677, while a breakdown below 0.8623 would open the door to levels below 0.8600.

Source: SpreadEx | EURGBP, 4-hour Chart