EUR/USD: Volatility Ahead of Fed, ECB Rate Decisions

Highlights

• Euro gains against the dollar, but caution prevails ahead of central bank meetings.
• Economists predict ECB to raise rates in June and July due to inflation pressures.
• Euro zone and U.S. economies expected to rebound, but ECB maintains aggressive tightening stance.

Overview

The Euro experienced a volatile trading session, gaining against the U.S. Dollar following a 0.4% increase last week, its first weekly gain in nearly a month. However, the Euro remains close to a multi-week low as traders exercise caution ahead of central bank meetings, including those of the Federal Reserve and the European Central Bank (ECB), which will announce their rate decisions.

At 11:30 GMT, the EUR/USD is trading 1.0767, up 0.0021 or +0.19%.

ECB to Raise Rates, Pause Amid Inflation Pressures

A Reuters poll suggests that a majority of economists expect the ECB to raise interest rates by 25 basis points on June 15, followed by another hike in July. However, due to persistent inflationary pressures, the ECB is anticipated to pause for the rest of the year after these consecutive increases. Economic activity in the euro zone, including Germany, has slowed over the past year, leading to a winter recession.

Euro Zone Rebound Expected

Despite the challenges, the poll indicates that both economies are expected to rebound in the current quarter, with the euro zone projected to achieve 0.2% growth each quarter for the remainder of the year. Although price pressures and inflation expectations have moderated, they have not subsided enough to dissuade the ECB from continuing its aggressive tightening cycle. ECB President Christine Lagarde emphasized the need for further rate increases and highlighted that it is too early to declare a peak in core inflation.

Economists Unanimous on ECB Rate Hike

All 59 economists surveyed in the Reuters poll forecast a quarter percentage point increase in the ECB’s deposit rate to 3.50% on June 15. The pace of rate hikes slowed at the ECB’s May meeting, following larger moves of 75 and 50 basis points. About three-quarters of economists expect another 25 basis point rate hike in July, aligning with market expectations and bringing the terminal rate to 3.75%.

Carsten Brzeski, the global head of macro at ING, expressed confidence in a 25 basis point rate hike for the upcoming meeting, noting that recent macroeconomic developments have favored the doves within the ECB. In contrast, the U.S. Federal Reserve is expected to maintain its pause at the June meeting and throughout the year, although some experts anticipate at least one more rate hike, likely in July. This may incentivize ECB policymakers to raise rates to maintain the Euro’s strength.

ECB Rate Forecasts Diverge Amid Inflation Concerns

Looking ahead, a majority of respondents predict that the ECB’s deposit rate will remain unchanged at 3.75% until the end of 2023. However, some economists forecast a lower rate of 3.50% or even a higher rate of 4.00% by year-end. The primary motivation for further action by the ECB is the insufficient decrease in inflation.

Euro Zone Inflation Exceeds Target, Expected to Persist

Euro zone inflation currently stands at 6.1%, over three times the ECB’s 2% target but lower than the peak of 10.6% in October of the previous year. The poll indicates that economists expect inflation to surpass the target until at least 2025, projecting average rates of 5.5% and 2.5% for this year and next, respectively. Core inflation, excluding volatile food and energy components, slightly declined and is anticipated to further moderate in the upcoming months.

Technical Analysis

The EUR/USD is edging lower on Monday in a volatile session. Friday despite a spike to the upside the previous session. The early price action suggests traders are still respecting the 1.0807 (PIVOT).

With the  trend down, sellers are likely to come in on the first test of 1.0807 (PIVOT). However, overtaking it will indicate strong counter-trend buying with 1.0979 (R1) the next target.

The inability to overcome 1.0807 (PIVOT) will signal the presence of strong sellers. This could trigger a resumption of the downmove with 1.0522 (S1) the next support target.