Hike rates

Deutsche Bank Updated Euro Forecast Says ECB Will Raise Rates In December

“Our strategists expect EUR/USD to significantly break above 1.20 by next year” – Deutsche Bank.

Image © European Central Bank, reproduced under CC license

The European Central Bank (ECB) will raise interest rates in December, according to Deutsche Bank, a call that could offer support for euro exchange rates going forward.

Deutsche Bank chief economist Mark Wall said he now expects the ECB to initiate a hike in policy rates with a 25 basis point hike in December 2022.

The call is in line with investor expectations, as implied by money markets, for a rate hike by the end of the year.

“If our ECB baseline forecast materializes without an acceleration in our Fed-expected up cycle, our strategists would expect EUR/USD to rise significantly above 1.20 by next year,” Wall said.

Euro exchange rate expectations

Above: “The deposit rate must reach 1% by the end of 2024, when the ECB can launch a bond-based QT” – Deutsche Bank.

  • EUR/USD reference rate on publication:
    Spot: 1.1289
  • High bank rates (indicative band): 1.0894-1.0973
  • Rate of payment specialists (indicative band): 1.1187-1.1233
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Deutsche Bank had previously forecast a rise of 10 basis points in December 2023, informing expectations of euro weakness in 2022.

Expectations of a rate hike in December come amid rising inflation in the euro zone, which is now well above the ECB’s official target rate. Eurozone annual inflation was 5.0% in December 2021compared to 4.9% in November 2021.

“Following the latest update to our HICP inflation forecast, the ECB’s ‘triple lock’ criteria should be met sooner than expected. Inflation is expected to decline further in 2022, but slower and less far,” says Wall.

A rate hike in December would mean that the gap between the ECB and other central banks that have already raised rates, or are entering a rate hike cycle, is closing.

For currencies, this is important as it provides some support for the Euro’s yield.

“In the event of a rate hike, the euro would likely strengthen more against the USD, JPY and GBP than against the Scandinavian and CE3 currencies,” Wall said.

The euro has struggled against the pound and the dollar in recent months as investors expect a more aggressive rate hike cycle at both the Bank of England and the US Federal Reserve.

While these two central banks will likely remain ahead of the ECB, at the very least a gaping rate disadvantage that has weighed on the euro for some time will narrow.

The ECB will likely react to signs of a growing spillover from durable goods prices to non-durables, Wall says. “It’s an indicator of greater inflation persistence.”

Core inflation in the euro zone is on the rise

Above: “Underlying inflation continues to rise rapidly” – Deutsche Bank.

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Wall also notes that labor market momentum is strong, bolstering his confidence that wage inflation will rise this year and feed through into service prices.

Deutsche Bank now expects deposit rate hikes of 25 basis points per quarter from December 2022 until rates reach +0.5% in September 2023, followed by less frequent hikes.

The terminal rate remains at 1.0% but is reached in 2024, i.e. two years earlier than expected.

“We also consider the ramifications of the ECB’s earlier takeoff for the euro exchange rate,” Wall said.

“Our FX strategists still see EUR/USD falling to 1.10 in the first half as any changes in messages from the ECB are likely to be delayed,” he said.

But Deutsche Bank strategists now forecast EUR/USD at 1.15 at the end of 2022 (vs. 1.08 previously) and 1.20, 1.25, 1.30 at the end of 2023, 2024 and 2025.

Deutsche Bank economists say any delay in a rate hike in 2022 could be triggered by a slower rise in wage inflation or a greater tightening of financial conditions due to TLTRO repayments.

The materialization of geopolitical risk is another potential delay factor; a fitting observation given the heightened tensions with Russia.

“If the ECB’s takeoff is delayed, the euro will remain significantly weaker,” Wall said.