The specter of stagflation in the EU greatly complicates the ECB potential to effectively use monetary policy. It becomes clear that commodity supply disruptions and trade contraction cement high inflation, while real output growth forecasts become less rosy as consumer demand may eventually begin to sag under the burden of rapid price increases. These concerns were reflected in the minutes of the last ECB meeting, which was released today. The release of the Minutes somewhat cheered up the Euro.

The document showed that most ECB policymakers believe that policy tightening should be started earlier and conducted faster than previously expected. This is not surprising as inflation in the Eurozone is breaking records - in March there was a sharp spike in price growth to 7.5%, due to the rally in commodity markets, in particular energy:

According to members of the Governing Council of the ECB, inflation will remain above the target in 2023, while inflation targets set for 2024 have already been achieved. APP asset purchases have also reached their stated objective, so the ECB is considering adjusting QE (decreasing monthly volume of bond purchases on the open market).

Since inflation is caused by rising prices for basic raw materials, the ECB has fair fears that it is transitory and follows fluctuations in commodity prices on world markets. Clearly, this is not the type of inflation that needs to be addressed with rapid policy tightening. But since the period of commodity inflation has been going on for too long, first due to post-pandemic imbalances, then due to the protracted Russian military operation, cost-push inflation may eventually gain a foothold in the inflation expectations of EU households. Then, of course, the ECB will also make a mistake, but only because it was late with decisive actions and the agents in the economy began to have expectations of future inflation already divorced from the ECB forecasts.

The ECB minutes were able to convince the debt market that rates would rise faster, with German 2-year bond yields up nearly 10bp. after release:

Apparently, the market regarded such rhetoric as a really serious step by the ECB towards normalization of policy. In this regard, EURUSD has a chance for a rebound, at least the technical picture is now conducive to this. The pair is approaching the previous yearly low, where a double bottom pattern could form. Nevertheless, the market may not wait for the movement close to 1.08 and move to an upside bounce on higher levels (1.0850 – 1.0875), since the gap between the policies of the ECB and the Fed is beginning to narrow and the progress in slapping direct sanctions on Russia energy exports seems to stall (which was the biggest factor of poor Euro performance at the start of the week):