The European Central Bank (ECB) raised its deposit rate to 2.25% last Thursday, marking its first rate hike since 2023 and reversing a streak of eight consecutive cuts [1]. ECB President Christine Lagarde emphasized a hawkish stance, rejecting the notion that this move was a one-off and signaling the possibility of further tightening, as the bank also revised its inflation forecasts higher [1]. Market participants are now anticipating another potential hike as soon as September, with even typically cautious Council member Philip Lane adopting a more hawkish tone [1]. German investor expectations turned positive for the first time since winter, though current conditions remain deeply negative, indicating optimism rather than a tangible recovery [1]. Core inflation remains near 2.5%, providing the ECB with justification for continued tightening [1].
Despite the ECB's hawkish actions, the EUR/USD exchange rate has shown limited movement, stalling at the 200-day Exponential Moving Average and remaining range-bound between 1.1550 and 1.1600 [1]. The market's attention has shifted to the upcoming Federal Reserve (Fed) meeting, which will be the first chaired by Kevin Warsh [1]. The Federal Open Market Committee (FOMC) is widely expected to hold rates steady at 3.50% to 3.75% [1]. However, the focus is on Warsh's approach to the Summary of Economic Projections (SEP), as he is known for his skepticism toward forecasting and forward guidance, potentially signaling a shift in Fed communication strategy [1].
Market pricing reflects roughly 60% odds of a December Fed hike, with no rate cuts anticipated through 2027, despite political expectations for cuts following Warsh's appointment by Donald Trump [1]. The recent energy shock, triggered by the Iran war and driving crude oil prices toward $120, was a key catalyst for the hawkish pivots by both the ECB and the Fed [1]. However, the situation has reversed following a US-Iran framework agreement that reopened the Strait of Hormuz, causing crude oil prices to fall back toward $80 and the US dollar to hit a 10-day low as the inflation premium diminished [1]. The ECB's June 11 hike occurred just as the energy-driven inflation spike began to unwind, and the upcoming Fed meeting may mark the first official acknowledgment of this reversal [1].
CONCLUSION
The ECB's unexpected rate hike and hawkish outlook have not translated into significant euro strength, as markets remain focused on the Fed's next moves under new Chair Kevin Warsh. With the energy shock fading and inflation pressures easing, central bank policy paths may soon adjust, but for now, market sentiment remains cautious and highly sensitive to upcoming Fed communications.