ECB Preview: Laying groundwork for rate hikes but EUR/USD could still fall

• The ECB is likely to keep key rates unchanged while hinting at a July lift-off.
• Details on the pace of the rate increases will rock the euro.
• The ECB is set to confirm an end of its QE program in Q3, economic projections closely eyed.

The European Central Bank’s (ECB) June 9 monetary policy decision is likely to be a highly significant one, as the central bank is seen signaling its first-rate hike in over a decade. Increasing signs of inflation broadening out in the old continent have compelled the ECB to prepare for a lift-off sooner than previously expected.

ECB rate hike forecasts hold the key

The ECB is unanimously expected to hold its benchmark deposit rate at -0.50% when it meets this Thursday to decide on its monetary policy. Although the central bank could announce an end of its regular asset purchase programme (APP) on July 1.

Despite being the laggards of the central banks to embark on the tightening cycle, ECB President Christine Lagarde has well telegraphed the upcoming rate hike track.

A clear signal for a July lift-off will be on the table, which will likely move the current deposit rate for the first time since 2014. It will be the first increase in the rates since 2011.

The specifics on the pace of the central bank’s tightening path, combined with the central bank’s growth and inflation forecasts will be closely examined. Last week's Eurozone inflation print hit a new all-time high at 8.1% YoY in May and core CPI accelerated 3.8% on an annualized basis.

As inflationary pressures broaden, markets will be more inclined to know if Lagarde and Company debated a 50 basis points (bps) rate hike for July or a smaller 25 bps hike, leaving room for rapid or double-dose rate hikes in the coming months.

Heading into the ECB decision, money markets are pricing in over 130 bps hikes by year-end, with a 50 bps move at a single meeting fully priced in by October.

Meanwhile, the central bank’s economic projections will be watched out for, given that a July rate hike is already baked in. Amidst looming recession risks, in the face of higher energy costs and supply chain crisis, a downgrade to the euro area growth estimates will not go down well with the EUR market should the ECB up its inflation forecasts.

Trading EUR/USD with the ECB

Risks remain skewed to the downside for EUR/USD in the run-up to the ECB showdown, as the main currency pair has confirmed a rising wedge breakdown on the daily chart on Wednesday.

EUR/USD: Daily chart

Meanwhile, the US dollar keeps the upper hand amid the renewed upside in the Treasury yields ahead of Friday’s inflation data.

Against this backdrop, EUR/USD could fall towards 1.0600 on the ‘sell the fact, buy the rumor’ trading should the ECB confirm the much-priced July rate hike.

Any hints on a probable double-dose lift-off could briefly power EUR bulls, which could be offset by any cautious remarks from the ECB Chief or by the growth forecast downgrade.

The upside in the major is likely to remain capped at around 1.0750. In case of a major hawkish surprise, hinting at aggressive ECB tightening, the previous week’s high near 1.0800 could be tested.