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The ECB signals it's not done yet... What does this mean for gold?

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Welcome to Kitco News' 2023 Outlook Series. Uncertainty continues to dominate financial markets as central bank monetary policies push the global economy into a recession to cool down inflation. Stay tuned to Kitco News to learn from the experts on how to navigate turbulent financial markets in 2023.

(Kitco News) - Inflation is far too high in the eurozone, forcing the European Central Bank to reaffirm its commitment to raising interest rates to significantly restrictive levels, according to ECB President Christine Lagarde.

As expected, the ECB raised interest rates by 50% basis points across the board and signaled that another aggressive rate hike will be coming in March, when the central bank will look to reevaluate its aggressive monetary policy stance.

According to analysts, markets see the ECB's reevaluation as a probable end to the tightening cycle as German bonds sell off and the euro falls to session lows against the euro. Weakness in the euro against the U.S. dollar is also creating some headwinds for gold, with the price falling below $1,950 an ounce. April gold futures last traded at $1,936.10 an ounce, down 0.21% on the day.

"What I heard was a dove who is prepared to pull the brakes on further rate hikes sooner rather than later. The euro and German bond yields have slumped, hence the reason why profit-taking has emerged in gold," said Ole Hansen, head of commodity strategy at Saxo Bank.

Although gold has pulled back from its recent nine-month highs, Hansen said that he still remains bullish on the precious metal.

"Overall, gold continues to pull above its weight if the dollar and yield were the only focus," he said. "The fact it continues to defy those – including me – looking for a correction must be due to continued demand from the physical market as well as hedge funds buying into the momentum."

Thorsten Polleit, chief economist at the European precious metal firm Degussa, said that he also expects March to mark the peak in European interest rates. He noted that while rates probably have to go higher to bring inflation down, restrictive levels will also cause significant problems for countries with elevated debt levels.

"The ECB is probably underestimating the downturn forces that are already underway in the euro area and the growing problems for the public finances of many euro area countries," he said in a research note translated from German. "From this point of view, monetary policy will probably amount to a kind of compromise solution in the coming months: ECB interest rates will rise less than is actually necessary, and inflation will remain higher for longer than would be desirable."

In this scenario, the euro could continue to struggle against the U.S. dollar, which would impact the global gold market. Polleit added, however, that he sees potential in the domestic market as the yellow metal remains attractive against the euro.

LBMA annual survey sees gold prices averaging the year around $1,859 an ounce, silver to hold around $23.65

"Persistently negative real interest rates in the euro area continue to make holding physical gold and silver attractive for investors. Holding these precious metals in physical form is a way of preserving the purchasing power of savings over the long term," he said.

But not everyone is convinced that the ECB will be ending its tightening cycle in the first half of 2023. Colin Cieszynski, chief market strategist at SIA Wealth Management, said that he expects the ECB to continue to raise rates longer than markets expect.

"I think the ECB still has a long way to go because they have a lot of catching up to do. They are so far behind inflation, so they need to continue raising interest rates," he said.

Cieszynski said that in this scenario, he sees further gains for gold as a hawkish ECB would drive the euro higher against the U.S. dollar.

"The euro has come off today, but it is still in a positive uptrend. Momentum in the U.S. dollar has slowed and I don't think that changes anytime soon," he said. "I am bullish on gold in the near term.

Lagarde herself pushed back on the idea the ECB is ready to pause after March. She stressed multiple times in her press conference that a revaluation of monetary policy doesn't mean the ECB will abandon its hawkish stance.

"We know that we have ground to cover. We know that we are not done," she said.

Lagarde added that once rates have peaked, the ECB is committed to maintaining its restrictive policies until inflation returns to its target.

"The Governing Council will stay the course in raising interest rates significantly at a steady pace and in keeping them at levels that are sufficiently restrictive to ensure a timely return of inflation to our two% medium-term target," she said in her opening remarks.

The comments come as European inflation rose 8.5% in January, down 0.7 percentage points from December's reading. However, components of inflation remain incredibly high. The ECB noted that food costs rose 14.% last month.

"Price pressures remain strong, partly because high energy costs are spreading throughout the economy," Lagarde said in her prepared remarks.

While inflation remains a significant threat, Lagarde did note an improvement in economic activity. She said the risks to economic activity are now roughly balanced.

"The energy shock could fade away faster than anticipated and euro area companies could adapt more quickly to the challenging international environment. This would support higher growth than currently expected," she said.

The ECB will release updated economic projections in March. Lagarde said that this is the data the central bank will use to determine if interest rates continue to rise by 50 basis points or 25 basis points, or "something else."

Market analysts at TD Securities also see markets underestimating the ECB's commitment to bringing inflation down. However, they noted that the euro was looking a little overextended against the U.S. dollar, so it's not surprising to see some profit-taking after the decision.

"We believe that the dovish market reaction was likely unintended, and look for the Governing Council hawks (and perhaps President Lagarde herself) to push back in the coming days via the media," the analysts said in a note. "EUR long positioning sits near the top of our tracking indicator, leaving it vulnerable to lofty market expectations. That said, we think dips will be short and shallow, and we like EUR upside versus USD, GBP, and CHF in the months ahead."

Disclaimer: The views expressed in this article are those of the author and may not reflect those of Kitco Metals Inc. The author has made every effort to ensure accuracy of information provided; however, neither Kitco Metals Inc. nor the author can guarantee such accuracy. This article is strictly for informational purposes only. It is not a solicitation to make any exchange in commodities, securities or other financial instruments. Kitco Metals Inc. and the author of this article do not accept culpability for losses and/ or damages arising from the use of this publication.