Fundamental analysis

The ECB’s difficult choice: let go of inflation or tighten the monetary police? The swan song of the euro in the monetary

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Ahead of the European Central Bank meeting scheduled for Thursday, October 27, the central bank faced a choice: to put up with rising inflation or “tighten the screws” on monetary policy. The euro is facing a difficult thing in the current situation, which was under the pressure of this choice.

According to analysts, the euro’s current rise, which on Wednesday, October 26, crossed the parity in the EUR/USD pair, is a kind of swan song, a short-term spectacular rise, which will come to naught after the central bank’s meeting. Many experts adhere to such a pessimistic scenario, although they allow short-term bursts of the activity of the euro.

Currently, core inflation in the euro area continues to increase. According to experts, in August 2022 it reached 6% year on year. Many analysts and market participants are confident in its further acceleration. Currency strategists at Natixis believe that the ECB will face a choice: to put up with continued high inflation until 2024 or move to a more aggressive monetary policy. Further choices will significantly affect the dynamics of the euro, which is now under the pressure of geopolitics and the energy crisis.

At the moment, the central bank has to admit that it is difficult to stop the growth of inflation, and the previous measures of influence are ineffective. Natixis analysts estimate that if core inflation exceeds 6% in early 2023, then by 2024 this figure will gain momentum, as “inflationary forces will be activated.” As a result, the ECB will either have to put up with growing core inflation of 6% over the 2023-2024 horizon, or continue to tighten the current monetary policy. Expectations of tighter monetary policy on the part of the central bank are due to skyrocketing inflation in the euro area, which reached an impressive 9.9% in September.

At the ECB’s upcoming meeting, the key issue will be to raise the interest rate by 75 bps, from the current 1.25% to 2%, as well as decisions related to the dynamics of preferential liquidity for banks (TLTRO). These questions will determine the euro’s succeeding direction, which has fizzled out lately, but continues to show short-term upswings from time to time.

The EUR/USD pair returned to a level above parity on Wednesday, October 26, but experts doubt the duration of the euro’s upward trend. The current growth of the pair is due to the short-term weakness of the dollar, which can gain momentum at any moment. The EUR/USD posted a strong intraday gain on Wednesday, consolidating above the parity level near the 55-day moving average and reaching a new six-week high near 1.0080. The pair’s next target is the 10-day SMA at 1.0092 and then the resistance at 1.0130. On Thursday morning, October 27, EUR/USD remained in its current range near 1.0077, trying to move higher, but mostly without success.

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Some experts are counting on a slight adjustment of the existing ECB rate. Rabobank’s currency strategists doubt that the central bank will continue to aggressively raise rates after the meeting. According to analysts, in the current economic conditions, it is more expedient for the central bank to slow down the pace of rate hikes. Rabobank analysts admit a decrease in the EUR/USD pair to 0.9500 in winter. Scotiabank economists disagree with them, who tend to maintain parity in the EUR/USD pair. According to experts, maintaining parity in the pair implies a further rise of the euro to the level of 1.0300.

Another surge in growth in the EUR/USD pair was recorded after the release of a positive report on the real estate market in the United States. In such a situation, the Federal Reserve has no need to raise the rate much, analysts believe. However, the current situation contributed to the subsidence of the greenback. As a result, the EUR/USD pair returned to parity, overcoming the downward trend in which it had been since the beginning of February 2022. Against this background, an increase in risk appetite and a fall in USD were recorded in the markets, thanks to which the euro got a head start.

However, a sharp rate hike by the ECB amid an impending recession may lead to negative results, experts believe. Against this background, the euro will be under pressure, and the EUR/USD pair may roll back to 0.9500-1.0000. Most analysts negatively assess the short- and medium-term prospects of the eurozone economy and expect the situation to worsen. According to experts, the onset of recession in the eurozone is a matter of time, which is aggravated by an unprecedented decline in business activity and the intensification of the energy crisis. If such a scenario is implemented in December 2022, Europe will enter a new round of the inflationary spiral, which will lead to a significant economic downturn.

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


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