The euro spiked against the dollar on Thursday as the European Central Bank (ECB) unveiled a surprisingly aggressive interest rate rise.
However, it began to retreat during ECB president, Christine Lagarde’s speech, indicating that markets are less than convinced by the efforts to tackle the gap between bond yields across the bloc.
"The euro has spiked to $1.025 vs the USD and the Italian & German 10-year yields are also up by 22bps and 10bps," Jesús Cabra Guisasola, senior associate in the global capital markets team at Validus Risk Management, said.
"Nevertheless, the prospect for the EUR remains gloomy in the months ahead as the ECB is facing one of the most difficult moments since the creation of the institution as the central bank is hiking to curb inflation while trying to keep under control the spread in yields between southern countries and Germany.”
The rate hike was a larger move than it had previously signalled, with financial markets pricing in a 25-basis point hike.
It marked the first rate hike in more than a decade, since 2011, and was the biggest jump since the year 2000, ending its experiment with negative interest rates.
It also comes amid pressure to follow the US Federal Reserve and other central banks, such as the Bank of England (BoE).
“The European Central Bank has at long last joined the rate hike club… However, the ECB is pushing on a string with rate hikes that will do little to quell what is predominantly an energy crisis,” Hinesh Patel, portfolio manager at Quilter Investors, said.
“The ECB has waited far too long relative to the Fed and the Bank of England, thereby creating additional pressure on the EUR which is adding to inflationary pressure.
Money markets are now betting on 60 basis points of interest rate rises at the ECB's next meeting in September, up from under 50 basis points before today's decision.
Eurozone inflation increased to 8.6% last month, more than four times the ECB’s 2% target.
Patel added: “Inflation is a major issue and will be for some time yet and the balancing act faced by the ECB remains a difficult one,”
“The bloc is faced with inflationary shock combined with ongoing uncertainty driven by the war in Ukraine, but the ECB’s previous inaction means today’s rate hike could well be too little too late.”
Watch: How does inflation affect interest rates?