Above: ECB president Christine Lagarde addresses the audience during the ECB Governing Council Press Conference on 21 July 2022, Frankfurt, Germany. Photo: Sanziana Perju/ECB.

The British Pound and U.S. Dollar recouped losses against the Euro in the hours following the European Central Bank's decision to proceed with a bold 50 basis point interest rate hike, with currency analysts saying the Eurozone faces significant challenges going forward.

The Euro rose sharply after the ECB announced the rate hike and said it had developed a mechanism that would ensure the Eurozone remains glued together should stresses start to result from higher interest rates.

This mechanism - labelled the Transmission Protection Instrument (TPI) - would seek to ensure the cost of servicing debt in debt-laden countries such as Italy would not surge in times of increasing stress.

But, the Euro's gains didn't last and it subsequently retreated after investors were left deflated by a lack of concrete details as to when and under what circumstances the TPI would be used.

The Pound to Euro exchange rate fell to a low of 1.1645 in the hour following the ECB's announcement but then started to retrace losses to go back to 1.1730. This as the Euro-Dollar exchange rate rose by nearly a percent to then retreat back to where it started the day.

Ultimately for foreign exchange analysts the ECB's policy update is a sideshow to more acute problems facing the Eurozone, which should ultimately weigh on the single currency going forward.

"The prospect for the Euro remains gloomy in the months ahead," says Jesús Cabra Guisasola, Senior Associate in the Global Capital Markets team at Validus Risk Management, following the ECB's rate decision.

He says the ECB will face 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.

"If the euro rallies on an ECB rate hike, the bounce won’t last long," says Kit Juckes, Head of FX Research at Société Générale.

Above: GBP/EUR at 15-minute intervals.

"Because in the background, we’ve still got a looming energy crisis as gas reserves can’t be built up ahead of winter, a political crisis in Italy, and a global economic slowdown that is just beginning to make itself felt," adds Juckes.

On the same day the ECB announced its interest rate increase its former President Mario Draghi tendered his second - and final - resignation as Prime Minister of Italy.

President Sergio Mattarella subsequently dissolved parliament, thus beginning a new election cycle.

The cost of servicing Italian debt rose, serving as a reminder to market watchers that Italy could be a key source of anxiety over coming months.

"The path for the euro going forward is now dependent on developments in Italy and European gas markets," says Simon Harvey, Head of FX Analysis at Monex Europe.

Brent Donnelly, CEO of Spectra Markets says he suspects the Euro will repeat its behaviour following the June ECB meeting and spend the next few days selling off, as Italian bond yields accelerate higher relative to those of Germany.

Donnelly is staying "short" the Euro.

Above: The ECB is forecast to raise hikes agressively, but within a brief window. Image courtesy of Wells Fargo.

But it appears the Euro is mostly exposed to weakness against the Dollar, which remains 2022's top performing currency.

The Euro is meanwhile sitting on a 1.20% advance against the Pound this week, highlighting that Sterling is struggling against its European counterpart, regardless of what the ECB does and the ongoing political uncertainty in Italy. (Set your FX rate alert here).

Nevertheless, should EUR/USD remain under pressure the prospect of a material advance in EUR/GBP will remain low, offering a reprieve to Sterling.

Alex Kuptsikevich, senior market analyst at FxPro says the ECB's rate hike is unlikely to spark a more protracted uptrend in the Euro.

"Amongst the significant fundamental obstacles to the appreciation of the single currency are the European economy, which is deeply mired in an energy crisis, and the extremely high debt/GDP ratios of some of the larger economies, which reduce the scope for fiscal stimulus," says Kuptsikevich.

He adds there are many questions about the sustainability of Eurozone growth in the near term despite a seemingly decisive ECB rate hike.

Developments regarding Russian gas flows into Europe will remain a key headline risk for the economy and Euro exchange rates over coming days and weeks.

"Fears that Russia will keep the gas pumps shut after the 10-day Nord Stream maintenance period have been allayed, with European nations breathing a sigh of relief as the key energy source starts to flow once again," says Joshua Mahony, Senior Market Analyst at IG.

The Nord Stream 1 pipeline began shipping gas into Europe following the successful completion of scheduled maintenance, but it is expected to do so at levels well below capacity.

"Traders should keep a close eye out for indications over quite how much product is flowing through the pipelines, with some fearing Russian manipulation of supply given Gazprom’s recent force majeure letter to European buyers," says Mahony.

With the war in Ukraine ongoing and gas prices remaining elevated the outlook for both the Euro and Pound Sterling is likely to remain challenged and the Dollar will likely remain preferred.