Fundamental analysis

Euro learns from past mistakes

It’s better to learn from someone else’s mistakes, but you always remember your own. In her first speech as Italy’s new prime minister, Giorgia Meloni slammed the European Central Bank, doing exactly what Liz Truss did during her 45-day tenure as UK PM. Truss’s cabinet ministers accused the Bank of England of hiking interest rates too slowly and allowing the pound sterling to collapse. Meloni, on the other hand, has claimed that the ECB’s monetary tightening runs the risk of impacting banking credit to families and businesses. Could Europe see another high-profile resignation soon?

It is quite unusual for EU heads of state to openly criticize the European Central Bank. However, it is unlikely to tsunami in the EU bond market, similar to what happened in the UK. After all, Giorgia Meloni did not propose fiscal stimulus, unlike Liz Truss. Furthermore, her verbal attack on the EU regulator is, in fact, quite reasonable. The higher the ECB hikes interest rates, the more the eurozone economy will suffer. But can the regulator avoid such painful measures amid record high inflation? Business activity in the eurozone is on the decline – a sign of looming recession.

Eurozone business activity

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Inflation in the currency bloc has been driven up by high energy prices, which have slid down recently. For example, natural gas prices has fallen below €100 per Mwh due to warm weather pushing demand down. LNG exports are on the increase, and storages are now full. According to Saxo Bank, energy prices could continue to fall, which in turn would influence inflation.

Nevertheless, a study by the European Commission says that changes in wholesale natural gas prices are typically only partially passed on to consumers, and can take up to 12 months to materialize. Increasing the deposit rate will hit the economy first and inflation later. Given the current energy price drop, the ECB could in fact consider refraining from aggressive monetary tightening.

EU gas price chart

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However, there is a problem. Market players have already priced in a 75 bps hike at the ECB Governing Council meeting on October 27. If this hike does not occur, EUR/USD could plummet, driving up already severely high import costs and accelerating inflation even further.

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Christine Lagarde and her fellow policymakers have no other choice but to continue tightening monetary policy. Expectations of such a move, alongside falling gas prices, the stabilization in the UK financial market and the US stock index rally, have pushed EUR/USD higher.

On the technical side, EUR/USD is testing the upper end of the fair value range, 0.963-0.9865, on the daily chart. If bulls come out on top, it would allow opening long positions once EUR/USD hits the short-term high at 0.99. Afterwards, short positions could be opened if the pair bounces off the resistance levels of 0.996 and 1.000. A breakout below 0.9845 will be a sell signal.

The material has been provided by InstaForex Company – www.instaforex.com


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