Even though the ECB left interest rates unchanged at 4 percent today, the Euro rallied as Trichet let the markets know that they have not given up on raising rates this year. The turmoil in the financial markets is a big concern for them and they feel that it is important to make sure that confidence is restored in the markets.
This morning, the ECB added another EUR42.2 billion in emergency funds to calm the credit markets - a strong signal that their work is not done. Yet fundamentally, for the time being, the ECB still feels that the medium term economic outlook is favorable which is why they believe monetary policy remains accommodative. However, Trichet specifically said that he did not use the words “strong vigilance” in his speech which implies that the ECB do not plan on altering interest rates in October. They still think that the risk to price stability (inflation) is to the upside but they want to watch incoming economic data before deciding what to do next. Trichet indicated that he will bring back the words “strong vigilance” if and when necessary. Even though the ECB will mostly stand on hold for the remainder of the year, which may be how long it takes for the credit markets to calm down, Euro traders are simply relieved that the central bank has not suddenly turned dovish.
Written by Kathy Lien, Chief Currency Strategist of DailyFX.com