Euro Attempts to Steady After Hit From ECB's New Dovish Guidance

© Reuters.

By Yasin Ebrahim

AiVIF.com –  The euro attempted to stage a rebound on Thursday, after falling to more than three-month lows following the European Central Bank’s unchanged monetary policy and new forward guidance that many believe could keep interest rates lower for longer.

EUR/USD fell 0.16% to $1.1773 after trading as highs as $1.1831 ahead of the European Central Bank decision.

The ECB, as was largely expected, left its benchmark rate at 0% and its commitment to purchase €1.85 trillion through March 2022 unchanged.

The central bank revised its forward guidance on interest rates to reflect its strategy review earlier this month. Under the new framework, the ECB would will inflation to overshoot target its 2% target.

The ECB said the adjustment of forward guidance meant “emphasizing its commitment to sustainably maintain an accommodative monetary policy stance to reach its inflation target.”

As this tweak ties the forward guidance on interest rates more closely to inflation, interest rates aren't likely to rise anytime soon.

“[T]he ECB did indeed make a shift towards more dovishness, putting more emphasis on the possibility of inflation overshooting and by tying the forward guidance on interest rates even closer to the inflation projections,” ING said.  “With an inflation projection currently of 1.4% YoY for 2023 and the new forward guidance, interest rates will remain low for even longer.”

Others agree, estimating that the central bank’s inflation target is unlikely to be met in the short-term.

“With its revised forward guidance on key interest rates, the ECB is signalling that it is likely to maintain its very expansionary monetary policy for a very long time,” Commerzbank (DE:CBKG) said in a note.

In the press conference that followed the policy statement, ECB president Christine Lagarde was quick downplay expectations that the revised forward guidance would result in a lower for longer interest rate environment.

“I’m not saying it’s going to be longer or lower,” Lagarde said. “I think it’s a sign that we don’t want to tighten prematurely.”

The ECB policy update is expected to exacerbate the divergence between a dovish ECB and a less dovish Federal Reserve, i keeping a lid on the euro against the dollar.

"We suggest selling EUR/USD as a way to play for upcoming USD upside risks," Morgan Stanley (NYSE:MS) said. "Increasing central bank divergence [...] a US inflation disappointment that pushes US real yields higher and breakevens lower, and the Fed moving closer towards reducing the pace of its asset purchases, all raise the prospects of USD strength in coming months."