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ECB To hike by 75 bps but No Big Euro Upside Expected

The ECB are expected to hike rates by 75 bps but this is priced in and we agree with this view: “We see limited upside risks for EUR/USD in the aftermath of the ECB announcement. This is mainly due to the weakened correlation between short-term rates and currency dynamics in the eurozone. This means that additional tightening being priced into the EUR curve on the back of a hawkish statement still looks unlikely to offer a sizeable, and above all, sustainable support to the euro.” (RABOBANK)

We agree the EUR should fall long term but short term, a weak dollar, and optimism about falling energy prices have driven it higher: “Warm weather is fuelling (relative) optimism about the energy crisis, even if Germany’s IFO data is deep into recessionary territory and the ECB’s Bank Lending survey shows financing conditions getting tougher.” (SOCIETE GENERALE)

Is the bad news discounted for the Euro? We don’t think so and see the rally more about short-term weakness than dollar strength. Speculators have gone heavily long the euro this month on the view the zone won’t have a long and deep recession it will in our view – we expect the rally to end and a resumption of the downtrend.

Euro Zone Economy and a Recession

Also, this is a good point about the problem the ECB Faces as core inflation is about to rise above 6%: “Econometric analysis shows that core inflation is perfectly inert (core inflation has an eigenvalue of 0.98). The ECB will therefore have to accept: Either core inflation of around 6% at least in 2024; Or a more restrictive monetary policy than is currently expected.” (NAXXIS)

They won’t go more restrictive as this will hurt the economy even more than the modest hikes expected. As the main rate moves towards the ECB's 2% target. In September, ECB President Christine Lagarde signaled that the tightening cycle would end in February. Markets have priced that borrowing costs will peak at 3% - Will Lagarde indicate more hikes to come? We doubt it.

Rate hikes done will not have a significant impact on inflation as the energy shock is from the supply side and not from demand – so all rate hikes do is hit businesses and the under-pressure consumer – the zone faces a recession going forward.

Slower Rate Rises in US Discounted 

A large part of the EUR/USD's recent rise has been fueled by the market assuming the Federal Reserve's "pivot" will lead to a slow up in rate hikes in the future. However, the US economy is still in far better shape than eurozone. 

Technical Analysis 

After the ECB look for a sell-off through support to trigger a move back to chart lows. If we do break first resistance look to sell back through it with a stop behind second level resistance.

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