Euro Bulls Look to ECB to Reignite Flame

Key points of the ECB review:

Read more: The Fed has paused for the time being but there are signs of a peak rate hike, and gold prices have turned the other way

As we head into a busy week for central banks, the European Central Bank’s interest rate decision has slipped somewhat under the radar as much of the focus has been on the US dollar and the US Federal Reserve. Much of this could be due to continued hawkish rhetoric from the European Central Bank which has been largely priced into making markets less sensitive to comments or data releases of late.

Markets are anticipating a 25 basis point rally this week with futures prices showing another rate hike in July before a pause. ECB staff expectations and comments after the meeting may give us a clearer indication of where central banks go from here, but I don’t expect any major surprises. Like many central banks, Thursday’s 25 basis point hike would bring the European Central Bank’s deposit rate to its highest level since 2008.

source: Refinitiv

The dilemma of inflation and the decline of the eurozone

On inflation, the Eurozone has seen some positives recently, but policy makers at the European Central Bank have stressed that there is still work to be done. Headline inflation has remained on a steady downward trajectory since it peaked in October 2022. The latest version came in at 6.1%, the lowest since February 2022 largely due to lower energy prices. Latent price pressures remain a concern in other sectors where food price inflation is a particular sticking point. The ECB seems to see that hiking up to an acceptable/constrained rate could be a smarter move rather than a pause and return to the highs as seen by the BoC and RBA.

Last night, the Fed saw a “tough pause” if you as Fed Chair Powell reiterated the need to slow down and assess the economy as the Fed approaches its expected peak rate. This should not have a significant impact on the ECB’s decision today or decisions going forward. ECB President Christine Lagarde emphasized this earlier that the ECB will monitor the Fed but will make its own decisions based on the available data.

The main sticking point going forward for the ECB is likely to be slowing growth with manufacturing data belatedly pointing to a slowdown as consumers prioritize needs. The ECB is likely to focus on service-sector inflation, and European tourists are on a rampage for fear that this will drive up prices even further.

Meanwhile, recently released first quarter revised GDP data confirmed that the Eurozone has entered a technical recession. Estimates for Q4 and Q1 growth have been revised from 0.1% to a contraction of 0.1% which could put the euro under pressure to go ahead and add the ECB board.

Possible scenarios and impact

rate of rise with doves tilt: A 25bps uptick seems certain at this point with employee expectations and public rhetoric likely to have a greater impact. Whether the economic outlook changes after the revised fourth quarter of 2022 and first quarter GDP data of 2023 remains to be seen, but will no doubt be a moot point. Any mention of inflation returning to target sooner than expected or more concerns about growth going forward could have negative repercussions and push the EUR lower.

rate of rise with hawk tilt: A 25 bps rally followed by persistent concerns about core prices and services inflation with no real sign of a recent technical recession could be interpreted as a ‘hawkish stance’ from the ECB. This along with any mention of further gains could reignite some EUR buying in the short to medium term.

artistic look

Technically EURUSD has been stuck in the 250 pips range for the past month as it searches for a clear direction. Yesterday we saw a bullish run ahead of the FOMC meeting with EURUSD giving up these gains since the beginning of the Asian session to trade around 1.0800.

However, the price broke and printed a daily candlestick closing above the 100-day moving average, with the pair remaining in an upside trend without a daily closing below the support handle of 1.0680. Higher prices remain my favorite medium and long-term direction for EURUSD, but from a daily perspective, a “dovish” 25bps ECB hike could push EURUSD back to 1.0700 areas again.

support areas

areas of resistance

euro/American dollar daily chart

source: TradingView, Reporting by Zain Fouda

— Written by Zain Fouda L DailyFX.com

Connect with Zain and follow her on Twitter: @employee