European Central Bank: Looking to raise rates again

With the Federal Reserve possibly moving to neutral by the end of the first quarter, the ECB could find itself as one of the only central banks left tightening rates after Q1. Low interest rates have created an environment of excess liquidity, with money-supply growth rates approaching 9 percent in an economy that is only expanding by 1.5 percent per year. Although consumer-price inflation growth is beginning to slow, it is still solidly above the central bank’s 2 percent pain threshold. Comments from members of the ECB remain mostly hawkish and there are forecasts that rates could be increased as aggressively as 25 bp increments on a quarterly basis, which would bring the repo rate to 3.25 percent by year end. Although this would still leave the European interest rate below that of the U.S., the compression in the interest rate differential would likely put a floor underneath any further decline against the U.S. dollar. In fact, the sentiment shift could also cause a nice knee-jerk rally in the EUR/USD.