ECB Quick Analysis: Hawks win major concessions, EUR/USD set to rise (assuming quiet spreads)

A Faustian bargain – German hawks probably wanted another jumbo rate hike of 75 bps hike but settled for a 50 bps one. However, they have emerged as winners once again, forcing concessions. 

First, the ECB has promised to continue raising significantly – and that word is, significant. It came after rates already rose by 2.5% and as the bank forecasts a mere 0.5% growth for next year, a weak level which is a downgrade from an already poor 0.9% projection. They are saying recession in all but name. 

The ECB will continue raising rates into a recession, a major victory for the hawks. That is positive for the common currency.

Another victory is the introduction of a program to reduce the ECB's balance sheet. The Frankfurt-based institution will not reinvest all proceeds from maturing bonds from March 2023. Fewer euros in markets means a strong currency.

However, this Faustian bargain has an Achilles heel. By buying fewer bonds, investors may fear that Italy may struggle to pay its debt down the road and sell the country's bonds. The third-largest country has a high 150% debt-to-GDP ratio and the ECB's announcement has triggered a sell-off in Italian BTPs. Widening German-Italian spreads reflect worries. 

So far, markets mostly believe the ECB will "do whatever it takes" to support Italy, at least as long as it implements the reforms it promised to according to the EU Next Generation program.

However, this ECB meeting, while being Euro-positive means traders should keep an eye on spreads.