Unlike the Fed, the European Central Bank is in a difficult situation. A continuation of the rate hike cycle could trigger a recession. If you give up early, inflation will accelerate. What to do? Let’s discuss this topic and make up a trading plan for EURUSD.
Weekly Euro fundamental forecast
Not so long ago, central banks acted decisively. They preferred to raise rates as quickly as possible for fear of doing too little. So great was the threat of high inflation consolidation. However, times have changed. Regulators worry that continued cycles of monetary restriction will trigger a recession or turmoil in financial markets. This is especially acute in the eurozone, where the ECB can trigger a recession by increasing the deposit rate. Fears of it are causing EURUSD to fall.
The Governing Council faces one of the most difficult challenges in history. If the ECB pauses, it will draw fire for its early surrender to inflation. On the contrary, an increase in borrowing costs by 25 bps to 4% risks ruining the economy.
Dynamics of industrial production and money supply in the eurozone
Source: Bloomberg.
Markets estimate the chances of a monetary tightening cycle continuation at 35% despite a number of aggressive speeches from ECB officials ahead of the September meeting. The most likely scenario for the development of events seems to be a hawkish pause. According to this, the deposit rate will remain at 3.75%, and Christine Lagarde will announce the central bank’s readiness to do more if necessary and that it has other ways to combat inflation.
In this situation, the euro risks weakening but then quickly recovering. Its stabilization would please ECB officials. Thus, a strong US dollar is a key driver of tightening financial conditions, which helps the Fed fight inflation. Its contribution to the growth of the indicator is greater than the rally’s impact on Treasury yields.
As a result, the Federal Reserve can feel calm, in contrast to the nervous ECB. The eurozone economy has been slowed by the war in Ukraine and the energy crisis, as well as deteriorating global trade. The share of exports in the eurozone GDP is greater than that of its American counterpart, as is the industry share in the economy’s structure.
Currently, the currencies of those countries that are focused on domestic consumption and services are especially popular. For example, in the US, USD takes advantage of the American exceptionalism. If inflation begins to accelerate, many will start making shock forecasts. For example, instead of the previous estimate of 1.15 for EURUSD, HSBC officials see the pair at 1.03 by the end of 2023. Capital Economics predicts parity. As a result, the consensus forecast of Bloomberg experts fell from the recent 1.12 to 1.09.
Dynamics of EURUSD forecasts
Source: Bloomberg.
Weekly EURUSD trading plan
The release of US CPI data and the ECB meeting are extremely important events. EURUSD consolidation above 1.072 may cause a correction. However, growth ahead of the release of inflation data is dangerous. For now, stick to long trades, but get ready to switch to shorts at any moment.
Price chart of EURUSD in real time mode
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