EUR/USD: Market Sentiment Cautious as ECB Prepares for Rate Increase

Highlights

• Euro strengthens against US Dollar on expected ECB rate hike.
• Fed’s hawkish stance prompts rise in short-dated bond yields.
• Market sentiment remains cautious due to declining inflation and euro zone slowdown.

Overview

The Euro is edging higher against the U.S. Dollar as expectations of an interest rate hike by the European Central Bank (ECB) intensify. This surge comes just after the U.S. Federal Reserve surprised markets with a hawkish stance. While the Federal Reserve kept rates unchanged, it left the door open for future increases, significantly surpassing market expectations. The Fed’s projections revealed a more hawkish tone than anticipated, with a higher projected funds rate and a greater number of members advocating for rate hikes.

ECB Balances Inflation and Rate Hikes

The ECB’s focus brings rising bond yields and a cautious stock market. Despite a potential rate hike to a 22-year high, the fight against inflation keeps further hikes possible. Some hoped for a pause, but the ECB aims to combat stubborn inflation. The deposit rate increase is expected, with room for more hikes despite a lagging economy. Euro Zone inflation stands at 6.1%, above the 2% target.

ECB’s Hawkish Tone Challenged by Declining Inflation

Interestingly, despite the Federal Reserve’s hawkish message, market pricing for future rate trajectories has not shifted significantly. Money markets currently expect only one more 25 basis point rate increase from the Fed. On the other hand, the ECB may struggle to adopt a hawkish tone due to declining inflation in the euro zone. Consequently, the euro has retreated slightly from its one-month highs reached on Wednesday, near $1.0865. ING analysts suggest that the euro/dollar exchange rate now faces moderate downside risks.

Key US Reports Could Influence Dollar

Looking ahead, key economic indicators such as the U.S. June Philly Fed index, May retail sales, and industrial production data will likely provide further direction to U.S. markets later today.

Short-Term Outlook:  Cautious Sentiment Surrounds ECB’s Hawkish Stance

In summary, the Euro has strengthened against the U.S. Dollar as the ECB prepares for a rate increase following the Fed’s hawkish message. The ECB’s decision to raise borrowing costs comes amid signs of a slowdown in the euro zone economy. Market sentiment remains cautious, with uncertainty regarding the ECB’s ability to maintain a hawkish stance amid declining inflation. The outcome of the ECB’s decision and its implications for the Euro Zone and global markets will be closely monitored.

Technical Analysis

The EUR/USD is edging higher on Thursday, continuing to build strength on the strong side of the 1.0807 (PIVOT), which is now support. If the upside momentum continues then look for a surge into 1.0979 (R1).

Breaking back below 1.0807 will signal the return of sellers. This could lead to a retest of 1.0635.