ECB Preview: Banking jitters give arguments for doves

• On Thursday, the ECB will announce its monetary policy decision. 
• A 50 basis point hike in key interest rates looks like a done deal, despite banking-industry jitters.
• Focus is on the forward guidance, “course in raising interest rates significantly” could be challenged.
• XAU/USD volatility might receive more fuel. 

On Thursday, the European Central Bank (ECB) will announce its monetary policy decision at 13:15 GMT. Later, at 13:45 GMT, ECB President Christine Lagarde will deliver a press conference. 

Back on February 2, the ECB raised rates by 50 bps as expected. In the first sentence of the statement, the central bank said, “the Governing Council will stay the course in raising interest rates significantly at a steady pace and in keeping them at levels that are sufficiently restrictive to ensure a timely return of inflation to its 2% medium-term target.” The forward guidance has been challenged during the last weeks by some members. They argue decisions should be taken meeting by meeting and based on incoming data. And then came the Silicon Valley Bank (SVB) drama. And then, Credit Suisse – Switzerland's second-largest bank – shares tumbled. 

High inflation vs banking industry concerns 

The ongoing turmoil in the banking system has become a factor of uncertainty. One more. Its impact is not yet defined. Contagion fears appear partially contained at times, but it could all change in the near future. The ECB has to decide on Thursday what to do with the mentioned context. The damage so far from the SVB drama is unknown. Such circumstances look unlikely to change the course of the 50 bps rate hike expected. ECB members are surely looking at recent developments, and the banking crisis could become the main focus; however, that will not change the fact that inflation is still very high. In February, the annual Consumer Price Index dropped modestly from 8.6% to 8.5%. The impact of the SVB and Credit Suisse crises is not enough, at the moment, to change the outcome on Thursday. It could change the projected path, the forecast of the terminal rate and the words of the statement. 

Banking jitters are fresh arguments for the doves at the ECB in their debate against the hawks. With high inflation and interest rates well below inflation, it seems likely that not even the doves will want to make a pause on Thursday (maybe a smaller hike) unless more banks hit the headlines over the next hours. For the next meetings, the situation is evolving so fast that there could even be some hawks asking for a pause. 

Lagarde’s press conference will be watched closely as usual, with the “extra” of the situation of the banking sector. Will she be able to lead the ECB to another significant rate hike after March? Will her message be conditioned by the opposition to “significant rate hikes ahead”? 

Gold in the current context 

The reaction in the currency market to the banking crisis has been milder compared to other markets, particularly bonds and commodities. 

Gold price jumped to the strongest level in a month, with a rally of more than $100. The run could be attributable to the sharp decline in global government bond yields. The yellow metal held on to most of its gains despite the rebound in yields seen on Tuesday; yields resumed the decline on Wednesday, boosting Gold to fresh highs.  

XAU/USD has been volatile in one direction despite the yellow metal usually offering impressive corrections. The ECB meeting arrives after a 7% rally in XAU/USD from last week's low. For Gold traders, it represents a factor that should be taken into consideration that could add fuel to volatility. Considering the last five ECB meetings, Gold reacted considerably in two. 

ECB’s decision could have a large impact on Gold prices through yields. If what the central bank says creates noise in the bond market, Gold will likely follow. Largade has the capability of influencing interest rate futures. Gold is unlikely to remain steady at times when EUR/USD makes big swings.