The European Central Bank (ECB) is moving back to normal monetary policy, but some challenges remain. Francois Villeroy de Galhau, a key policymaker, mentions that during unusual times, the return to normal may take longer than expected. The ECB will keep a close watch on possible energy price impacts and adapt to changes that could affect inflation. Currently, inflation expectations suggest there is no risk of long-lasting effects. A 10% rise in the euro’s value could counteract a €10 increase in oil prices. The ECB is ready to respond in future meetings, and any new monetary policy might trend toward easing, unless major external shocks occur.

The Summer Pause

Throughout the summer, the ECB will take a break to review various factors affecting their decisions. While trade and geopolitical risks exist, they are considered temporary and not expected to be significant concerns for the ECB in the long run. This article explains that ECB policymakers are gradually moving away from the emergency measures they put in place in recent years, such as slashed rates and aggressive asset purchases. However, as Villeroy noted, the path to normalization is not guaranteed. Past issues have lasted longer than anticipated, and what seems temporary can still affect inflation or currency values by shifting expectations. Two important observations emerge. First, the euro’s strength acts as a buffer. If the euro rises by about 10% against other currencies, it can negate the effect of an oil price spike that would otherwise lead to higher consumer prices. This could explain why the central bank feels less worried about inflation driven by energy costs. Second, current inflation expectations remain stable. So far, there are no signs that workers, companies, or consumers are altering their long-term price expectations. Given this context, we shouldn’t assume that interest rate hikes are guaranteed for the rest of the year. In fact, unless unexpected events arise outside Europe, the central bank may lean toward easing policy next. This doesn’t mean immediate rate cuts; it’s more about staying flexible. Monitoring, pausing, and reviewing data are now the priorities. The summer will focus on taking a breath rather than making bold changes.

Market Volatility and Risk Management

For those monitoring price movements in the short term, it’s crucial to understand that this kind of pause often results in tighter trading ranges. If there is no clear policy change, spreads across euro-linked assets may narrow, especially as it seems inflation risk from trade or global conflicts isn’t yet having a lasting effect. Recent issues—like trade tensions or regional security challenges—haven’t disrupted inflation target expectations. If you’re looking to position around rates in eurozone products, timing is key. The summer often sees lower trading volumes; thus, significant data on inflation, wage growth, or consumption could disrupt the current calm, affecting implied rates and volatility. Events that we typically overlook can trigger significant reactions during quieter months. It’s helpful to view the ECB’s caution as a way to maintain control, rather than as uncertainty. They appear determined to avoid creating false expectations in the markets. Therefore, keeping an eye on updates from Governing Council members, particularly their tone, is more important than last meeting’s minutes or older forecasts. We interpret this cautious stance as gently dovish without explicitly saying so. For those analyzing term structures or calendar spreads, this could shift probabilities toward a flattening curve, assuming no major surprises from energy markets. Short-term rates may remain stable, while longer rates might change if inflation trends downward in the third quarter. When planning for risk, we suggest that contracts near the next ECB meeting should show limited movement unless new supply-side news arises. Being cautious around those dates makes sense; however, fading quick reactions may provide more opportunities than chasing them. Create your live VT Markets account and start trading now.

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