With economic data suggesting that the Euro area may have dodged a severe recession and underlying inflation not showing any signs of slowing yet, investors have dramatically raised their ECB hike bets. Ergo, this week, they may be sitting on the edge of their seats in anticipation of Thursday’s preliminary CPI data as they try to figure out whether the ECB will proceed with the telegraphed 50bps hike or a bigger increment at the upcoming meeting. The data comes out at 10:00 GMT and the enigma is how will the numbers affect the euro.
Outlook warrants more sizable hikes
At its last meeting, the ECB raised interest rates by 50bps as was widely expected, with President Lagarde explicitly saying that they intend to raise them by another 50bps in March and then evaluate the future path on a meeting-by-meeting basis based on the data. She also added that supply bottlenecks are gradually easing, but the delayed effects are still pushing up goods price inflation.
Indeed, headline inflation has slowed notably after peaking at 10.6% in October and could slow even further in the months to come as the war-related rally in energy prices drops out of the year-over-year calculation. However, underlying inflation is proving stubborn, not showing signs of a slowdown yet. On top of that, just last week, Eurozone’s preliminary PMIs for February were largely better than expected, with the composite PMI rising to 52.3 from 50.3 and adding to hopes that a previously feared recession may be sidestepped.
The blend of such economic figures allowed ECB policymakers to become more vocal about the need for more double hikes. The only policymaker sounding a bit cautious lately was Chief Economist Philip Lane, who noted that the Governing Council may not need to proceed as forcefully as previously planned.
Investors see decent chance for a triple hike in March
With all that information in hand, market participants are now assigning a nearly 40% probability for a 75bps hike at the upcoming gathering, with the remaining 60% pointing to the telegraphed 50bps increment. Moreover, they are projecting a total of 155bps worth of additional hikes until the end of the year, while just a couple of weeks ago, they were seeing only 100bps.
And yet the euro has been on the back foot against its US counterpart, and that’s because investors have been lifting their Fed implied rate path as well. So, will this week’s inflation data wake up the euro bulls? The headline rate is forecast to slide further to 8.2% y/y from 8.6%, while the core rate is anticipated to just pull back to 6.9% y/y from 7.1%. The euro could retreat somewhat on cooling inflation rates, but with the core one staying near 7%, ECB hike bets are unlikely to be altered much.
Euro may perform better against the loonie
This could keep some euro bulls in the game and thereby complicate things for euro/dollar sellers. Nonetheless, it could also increase the downside risk in the case of an upcoming economic data point disappointing. The same goes for the dollar. Therefore, the outlook for euro/dollar seems somewhat blurry for now. Maybe both currencies will perform better against the risk-linked ones as increasing hike expectations have been weighing on risk sentiment lately. With the slowdown in Canada’s inflation for January and the nation’s disappointing GDP data for Q4 congealing expectations that the BoC may refrain from hiking rates further, the loonie may be the best choice.
Euro/loonie has been trading higher recently, but still within the sideways range between the 1.4235 support and the strong resistance of 1.4535, which acted as a ceiling, not only recently, but also back in December 2021 and January 2022. In the bigger picture, the pair is still lying above both the 50- and 200-day EMAs, as well as above the uptrend line drawn from the low of August 25. This keeps the door for further advances wide open.
If underlying inflation in the Euro area remains at elevated levels, the bulls may be tempted to challenge the 14635 zone in the foreseeable future, the break of which would confirm a higher high and may set the stage for a gradual advance towards the 1.51 territory, which acted as a solid wall against the bulls between July and September 2021.
Alternatively, if Thursday’s inflation rates miss their forecasts, the euro is likely to lose ground, with euro/loonie perhaps coming back down to the 1.4235 barrier. That said, even if that zone gets broken, the pair would still be trading above the aforementioned uptrend line, something that might keep the bigger outlook cautiously positive.