Euro Reaction to ECB Rate Decision Will Hinge Upon Trichet's Comments

The Euro held onto its gains today ahead of tomorrow?s much awaited ECB interest rate decision.

The market has completely priced in a 25bp rate hike, which suggests that the EUR/USD will probably not budge on the actual rate announcement. Instead, what will move the Euro are the comments from ECB President Trichet at the accompanying press conference. We expect Trichet to remain optimistic about growth but intentionally drop forgo using the words “strong vigilance” regardless of whether he expects to raise interest rates beyond June or not. This was exactly what he did after the last 2 rate hikes in March 2007 and December 2006 even though the ECB moved on to raise rates again in the following months. The bigger surprise to the markets will not be the continually hawkish comments by the central banker but instead more dovish ones. Recent economic data has been mixed. Even though the futures curve is pricing in 4.25 percent rates by year end and the economy could probably handle that, the ECB may want to see how the region responds to the latest rate hike before instituting another one. We mentioned yesterday that it is extremely rare for the ECB to raise rates back to back. Therefore even if rates are to be increased again, it may not be until September at the earliest. This morning?s economic releases were conflicting. Retail sales in the month of April fell short of expectations while service sector PMI accelerated. Aside from the interest rate decision, we also have German factory orders tomorrow.