EUR/USD trades virtually flat near 1.1623 during American trading hours on Tuesday. The US Dollar (USD) struggles to hold its earlier gains, helping the Euro (EUR) recover from its intraday low.
The US Dollar Index (DXY), which tracks the Greenback’s value against a basket of six major currencies, trades around 98.82 after briefly reclaiming 99, hovering near its lowest level in more than two weeks.
The Greenback struggles to gain traction despite hawkish Federal Reserve (Fed) expectations. Escalating tensions in the Middle East do little to revive defensive demand for the currency, which is largely weighed down by the sharp rise in the Japanese Yen (JPY).
Fresh hostilities in the Middle East keep Oil prices elevated, adding to inflation concerns and strengthening the case for tighter monetary policy. The US Producer Price Index (PPI) on Thursday and Consumer Price Index (CPI) on Friday will be the next major test for the Fed ahead of its policy decision.
According to the CME FedWatch Tool, markets see around a 60% chance that the Fed will raise interest rates by 25 basis points at its September 15-16 meeting.
On the Euro side, attention is firmly on the European Central Bank’s (ECB) interest-rate decision on Thursday. The ECB is widely expected to raise its deposit rate by 25 basis points to 2.50%, with markets fully pricing in the move. This would be its second rate increase this year after the June hike.
Eurozone inflation accelerated to 3.3% in August from 2.9% in July, largely due to higher energy prices. As the rate hike is already priced in, the Euro’s reaction could depend more on President Christine Lagarde’s comments and the ECB’s updated economic projections. Traders will look for signs of whether policymakers are considering another increase after September or plan to pause.
Analysts at ING highlight that the latest data revisions have reinforced the Eurozone’s growth narrative, with second-quarter output “revised up from 0.4% to 0.6% QoQ, driven by stronger Irish growth on the back of robust multinational performance.” They note that, more broadly, “Europe’s resilience despite geopolitical developments and higher commodity prices remains a key theme of the summer and has likely helped keep the euro relatively expensive.”
Even so, ING maintains a cautious stance on the currency pair, stressing that “our short-term downside preference in EUR/USD is still mainly driven by our USD view and expectation of a September Fed hike.” The bank adds that “the latest rise in energy prices adds further support” to this bias, reinforcing their view that the Euro’s current strength may prove difficult to sustain in the near term.
ECB FAQs
The European Central Bank (ECB) in Frankfurt, Germany, is the reserve bank for the Eurozone. The ECB sets interest rates and manages monetary policy for the region.
The ECB primary mandate is to maintain price stability, which means keeping inflation at around 2%. Its primary tool for achieving this is by raising or lowering interest rates. Relatively high interest rates will usually result in a stronger Euro and vice versa.
The ECB Governing Council makes monetary policy decisions at meetings held eight times a year. Decisions are made by heads of the Eurozone national banks and six permanent members, including the President of the ECB, Christine Lagarde.
In extreme situations, the European Central Bank can enact a policy tool called Quantitative Easing. QE is the process by which the ECB prints Euros and uses them to buy assets – usually government or corporate bonds – from banks and other financial institutions. QE usually results in a weaker Euro.
QE is a last resort when simply lowering interest rates is unlikely to achieve the objective of price stability. The ECB used it during the Great Financial Crisis in 2009-11, in 2015 when inflation remained stubbornly low, as well as during the covid pandemic.
Quantitative tightening (QT) is the reverse of QE. It is undertaken after QE when an economic recovery is underway and inflation starts rising. Whilst in QE the European Central Bank (ECB) purchases government and corporate bonds from financial institutions to provide them with liquidity, in QT the ECB stops buying more bonds, and stops reinvesting the principal maturing on the bonds it already holds. It is usually positive (or bullish) for the Euro.
