Euro: Yield gap drives downside risk against US Dollar – MUFG

MUFG’s Lee Hardman notes that EUR/USD has broken below its long-held 1.1400–1.1800 range as diverging ECB and Fed policy expectations weigh on the Euro. Softer Euro-zone data and easing energy prices are reducing pressure on the ECB to hike further, while the Fed is priced for multiple hikes. MUFG still expects one final ECB rate increase in September.

Diverging ECB-Fed paths pressure Euro

"The US dollar’s upward momentum has continued at the start of this week resulting in EUR/USD falling to a low of 1.1361 overnight. The pair has now broken out of the 1.1400 to 1.1800 trading range that had been in place over the past year providing a bearish technical signal."

"The combination of weaker growth in the euro-zone and lower energy prices is helping to ease pressure on the ECB to hike rates further. President Lagarde stated at the start of this week that “we see no evidence yet of de-anchoring of inflation expectations or second-round effects that warrant a more forceful policy response at this stage”."

"We are still sticking to our forecast for one final ECB hike in September, although acknowledge that balance of risks has shifted recently in favour of less rather more hikes."

"Recent comments from ECB Chief Philip Lane have indicated that they want to keep the door open for at least one final hike. He warned yesterday that a “range of forward-looking signals point to inflationary pressures in the coming months” and that “in this environment, our focus remains clear: to ensure that inflation stabilizes at our 2% target in the medium-term”."

"The divergence in monetary policy expectations between the ECB and Fed is likely to continue to encourage a lower EUR/USD in the near-term, although we doubt it will be sustained if the Fed does not follow through with rate hikes this year."

(This article was created with the help of an Artificial Intelligence tool and reviewed by an editor.)