EUR/USD bulls take charge on hawkish ECB commentary

EUR/USD has been trading near a 9-month high for the best part of the start of the week as the market's bank on rate hikes from the European Central Bank at the same time that they start to price a less aggressive Federal Reserve. EUR/USD vaulted the prior higher and scored a fresh bull cycle high of 1.0927. 

In trade on Monday,  futures have priced out almost any chance the Fed could move by 50 basis points next month and have steadily lowered the likely peak for rates to 4.75% to 5.0%, from the current 4.25% to 4.50%. By contrast, ECB policymaker Peter Kazimir said on Monday that inflation easing was good news but added that it was not a reason to slow the pace of interest rate hikes, as reported by Reuters. 

"I am convinced that we need to deliver two more hikes by 50 basis points," Kazimir said and acknowledged that the Eurozone economy was faring better than expected one-two months ago.

 Governing Council member Ignazio Visco also said on Monday that Italy can deal with the impact of a 'gradual but necessary' rate of monetary policy tightening. 

"Alarms that are sometimes raised about effects that further ECB rate increases could have on the Italian economy cannot be shared," Visco added. "I believe it is entirely possible to reach the ECB target of inflation at 2% while avoiding particularly negative impact on the eurozone economy and the labour market."

Governing Council member and Governor of Austria's central bank Olli Rehn made some comments on the central bank’s interest rates policy during his appearance over the weekend.

He said that he sees grounds for "significant interest rate increases from the ECB this winter and the coming spring.”

Reuters also reported that the European Central Bank (ECB) is set to raise interest rates by 50 basis points in both February and March and will continue to raise rates in the months after, ECB governing council member Klaas Knot said in an interview with Dutch broadcaster WNL on Sunday.

"Expect us to raise rates by 0.5% in February and March and expect us to not be done by then and that more steps will follow in May and June," Knot said.

In more recent trade, ECB President Christine Lagarde largely repeated the bank's most recent policy guidance. "We have made it clear that ECB interest rates will still have to rise significantly at a steady pace to reach levels that are sufficiently restrictive, and stay at those levels for as long as necessary," Lagarde said in a speech.

Analysts at ANZ bank explained that Europe is yet to see a turnaround in core inflation, unlike the peak seen in the US. ''Our forecast profile anticipates that rates will rise by 50bp when the ECB meets next week and that rates will rise 25bp another two times after that. However, that profile is highly data dependent and with the outlook for the euro area economy brightening, the risks are to the topside.''

Looking ahead for EUR/USD

Later in the week, flash surveys on January economic activity due this week are forecast to show more improvement in Europe amid falling energy costs than in the United States.

We also have red news on the US calendar. Core PCE prices likely accelerated to a 0.3% MoM pace in Dec, though a 0.4% gain can't be discarded. The YoY rate likely slowed to 4.5%, suggesting prices continue to moderate but remain sticky at high levels, analysts at TD Securities pointed out. In terms of Gross Domestic Product, the analysts said, ''we also look for Gross Domestic Product growth to have stayed strong in Q4, posting another above-trend gain. Growth was likely supported by firm showings from the consumer and inventories.''

With regards to the outlook at the Federal Reserve, analysts at Brown Brothers Harriman explained that they are of the opinion that the market is underestimating the potential for a higher for longer Federal Reserve. ''Core Personal Consumption Expenditures, PCE, has largely been in a 4.5-5.5% range since November 2021,'' they said. ''We think the Fed needs to see further improvement before even contemplating any sort of pivot.''

Analysts at Rabobank said that while there 1-month forecast stands at 1.09, they see room for a move lower to 1.06 on a 3-month view.  ''This assumes the Fed reasserts a more hawkish position on policy than the market currently expects.  It also takes into account the risk that Europe’s energy crisis is far from over.''