ECB Previews: Lagarde to lash the euro down as cannons are heard and stagflation looms

• The ECB is the first major central bank to meet in wartime. 
• Higher commodity costs and recession risk to the eurozone.
• President Lagarde will likely highlight uncertainty and refrain from signaling rate hikes.
• The vulnerable euro will probably suffer another blow.

It is hard to envy European Central Bank staff trying to provide updated economic forecasts – Russia's invasion of Ukraine upended any reasonable way to make predictions beyond a short horizon. That kills any hawkish expectations, and will likely down the euro.

Back in the previous meeting, ECB President Christine Lagarde emphasized the importance of new forecasts in March to determine the path of the bank's bond-buying scheme and potential rate hikes later in the year. By refusing to commit to leaving rates unchanged, the former politician left the door open to a historic increase in borrowing costs to fight rising inflation – assuming updated forecasts supported it.

Since that February 3 meeting, new evidence of inflation indeed arrived – the headline Consumer Price Index hit 5.8% YoY, higher than expected, and Europe's usually sluggish Core CPI also exceeded estimates, reaching 2.7% compared to a year ago. 

Source: FXStreet

War and the ECB

However, something else happened in February – Russia invaded Ukraine, and unless a miracle happens, fighting is set to continue during the ECB meeting. The mere threat of cutting off Europe from Russian oil and gas has sent prices higher. Ukraine and Russia also produce massive amounts of wheat and other soft commodities, and the war prompted a sharp appreciation in these too.

Higher inflation means accelerated rate hikes to fight it, doesn't it? Not when it becomes too extreme. If European pockets are squeezed due to basic costs, they will have fewer funds to purchase other goods, services, or vacations. Inflation may destroy demand, thus crippling the eurozone economy.

Natural gas is shooting higher:

Source: TradingEconomics

The potential for such a scenario of stagflation is undoubtedly causing sleepless nights at the ECB's headquarters in Frankfurt and could result in looser monetary policy down the road – prompting a euro sell-off.

At this juncture, Lagarde, her colleagues and staff tasked with forecasting are likely to lift their hands in the air and just say they have no idea what will happen next. The fact that they leaned to the hawkish side a month ago means a blow for the euro. 

Hasn't the common currency already paid its war dues? EUR/USD significantly tumbled, but there is a difference between speculation and the central bank's official change of direction. Any fear of rising unemployment and stagflation could trigger the next leg lower in the world's most popular currency pair, rather than result in a "buy the rumor, sell the fact." 

Final Thoughts

With the current focus on the war, it seems that only a broad ceasefire could significantly boost the euro. Even if Lagarde tries to sound optimistic and boosts the euro during her press conference, the common currency could resume its downtrend afterward.