Early morning yesterday, European investors received a surprise potential leak that the European Central Bank is considering raising interest rates by 0.50%, deviating from its guidance last month of a 0.25% increase, because of a worsening inflation backdrop and the potential for Russia to shut off all gas flows via Nord Stream 1. The market freaked out on this news, pushing the EURUSD rate off parity and back to 1.02 EUR/USD.
However, if the ECB decides to back off this “leaked” information and only raises by 0.25% on Thursday, investors should expect the recent move to reverse and the Euro to potentially break parity with the U.S. Dollar. It was less than two months ago that Christine Lagarde’s, ECB Chairwoman, plan to exit negative interest-rate policy by the end of 3Q was seen by some ECB members as not aggressive enough. Yet, the headwinds facing Europe have accelerated since then, which could mean the rate hiking window closes very quickly. All of this suggests interest-rate differentials will continue to favor the dollar and weigh on the euro causing the Euro to lose parity with the U.S. Dollar, something not seen in the last 20 years.