The end of October and the beginning of November seems to be hectic time in the foreign exchange market, as the European Central Bank has already communicated its interest rate decisions, and the US Fed will do so on November 2. As a result, the forex market may see above-average volatility.

Yesterday the European Central Bank raised its three key interest rates by an expected 75 basis points, the third consecutive hike. It could confirm the ECB's determination that further policy tightening would continue until inflation approaches its 2% target.

The main refinancing operations rate and the central bank lending and deposit rates were raised to 2%, 2.25% and 1.50%, respectively, with the decision taking effect on November 2. BBN reported that the ECB said that the current inflation rate, which stood at 9.9% last month, remains "far too high" and would remain at elevated levels in the coming months. 

How did the euro exchange rate react to the ECB's decision?

Source: Conotoxia MT5, EURUSD, H1

The euro exchange rate fell immediately after the ECB decision, perhaps because the market expected a more hawkish stance. The Bank has changed its statement that interest rates will rise at future meetings to a statement that decisions will be made from meeting to meeting. As a result, the market has pushed back its expectations by a full 25 bps, and is perhaps hoping for a softer tone from the ECB due to a potential recession in 2023.

Statements after the ECB decision - will they affect the euro?

According to the BBN website, Bank of Lithuania head Gediminas Simkus argued on Friday that the next interest rate hike must be significant. A Simkus hinted at the possibility of the ECB raising key rates by another 75 basis points after yesterday's hike, noting that this should not be the new norm. He also shared expectations that the ECB will raise inflation projections in December. In contrast, Bank of France Governor Francois Villeroy de Galhau said Friday that the European Central Bank needs to be cautious in the way it will approach quantitative tightening. However, he expects rapid moves toward normalizing interest rates, BBN reports.ECB President Christine Lagarde said yesterday that the bank's governing council will formally discuss a reduction in the asset purchase program (APP) in December.

What can the Fed do?

Recent data from the US show a decline in inflation and a drop in activity in the industrial sector and the real estate market. As a result, the market seems to expect that the Fed may begin to slow down the pace of interest rate hikes, and after the November hike, the chance of an end to the cycle in Q1 2023 seems to be increasing. Moreover, the market may expect that the Fed will still cut interest rates by 50 bps next year. Such expectations could have a negative impact on the US dollar and could strengthen the euro, but confirmation of this could be possible on November 2.

Daniel Kostecki, Director of the Polish branch of Conotoxia Ltd. (Conotoxia investment service)

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