The euro to dollar rate (EUR/USD) has slid below $1.068, marking its lowest point in three months, as the European Central Bank (ECB) hiked interest rates for the tenth consecutive time, raising them to the highest level since 1999, and signaled a temporary pause in its monetary tightening efforts.
The euro witnessed a 0.3% decline following the announcement by ECB policymakers to raise interest rates by a quarter-point, reaching 4 percent, as was anticipated by many investors. The move failed to boost the currency, as it was trumped by expectations of the hike being the ECB’s final tightening.
This policy move comes at a time of heightened investor apprehension regarding an impending economic downturn, which has been reaffirmed following the European Commission's recent downgrade of growth forecasts for the 27-country union to 0.8% for this year and 1.4% for 2024.
ECB policymakers conveyed that current borrowing costs have reached a level where, if maintained over an adequate timeframe, they would make a significant contribution to bringing inflation back to its target level. Nonetheless, inflation is expected to remain elevated for an extended period, despite its current downward trajectory.
The ECB has now increased borrowing costs for ten consecutive policy meetings since July 2022, aiming to combat rampant inflation.
In recent days, both investors and policymakers have expressed growing concerns about persistent price pressures, especially with oil prices surging to 10-month highs following supply cuts by leading producers Saudi Arabia and Russia.
According to the ECB's economic forecasts, the Euro Area anticipates an average inflation rate of 5.6% in 2023 (compared to 5.4% in the June projection), 3.2% in 2024 (versus 3.0%), and 2.1% in 2025 (compared to 2.2%).
Stronger-than-expected inflation data from the United States has also further solidified the case for prolonged elevated interest rates in the country, although markets are expecting the Federal Reserve to leave rates unchanged at the upcoming Federal Open Markets Committee meeting next week, while the probability of a hike at the November meeting currently stands at 35%, as per CME’s FedWatch tool.
In a comment cited by FXStreet, UOB Group’s Economist Lee Sue Ann and Markets Strategist Quek Ser Leang noted that a deeper drop could drag the euro to dollar rate to the 1.0515 zone in the upcoming weeks:
“The sharp selloff that sent EUR plunging to a 6-month low of 1.0629 came as a surprise (we were expecting EUR to trade in a range). While the decline appears to be overdone, the weakness in EUR has not stabilised. Today, EUR could decline further, but it is unlikely to break clearly below 1.0600. Resistance is at 1.0665, a break of 1.0690 would mean that EUR is not weakening further.”
“Next 1-3 weeks: On Tuesday (12 Sep, spot at 1.0750), we indicated that ‘the weakness in EUR has stabilised’, and we held the view that EUR ‘is likely to trade in a range between 1.0690 and 1.0820.’ Yesterday (14 Sep, spot at 1.0730), we highlighted that ‘Looking ahead, if EUR breaks and stays below 1.0690, it will increase the risk of it dropping towards the major support at 1.0635.’ In London trade, not only did EUR break below 1.0690, it also dropped slightly below May’s low of 1.0635 (low has been 1.0629). The sharp increase in momentum suggests EUR has resumed its weakness. However, it remains to be seen if there is enough momentum to carry EUR lower March’s low near 1.0515. In order to keep the momentum going, EUR must stay below 1.0730, the current ‘strong resistance’ level. This level will move lower in the coming days.”
In their FX Snapshot released on September 4 — a EUR/USD projection that is yet to be updated — analysts at Citibank Hong Kong accurately foresaw the ECB’s decision to hike rates:
“Citi analysts still expect an ECB hike in September to 4.00% and for rates to remain at this level potentially through to Q3 2024. Market pricing supports a significant narrowing of rate differentials in favor of EUR versus USD from 2024 onward. Overall, the trading range in EURUSD has been steadily shifting higher which augurs well for the pair later this year as the ECB keeps financial conditions tighter for longer than most, if not all other [advanced economy] central banks including the Fed.”
Citibank slightly lowered its EUR/USD forecast for the next three months to an average of $1.10 (previously $1.11) and adjusted its 6 to 12-month euro-to-dollar projection to $1.14 (previously $1.16). The bank’s long-term EUR/USD projection stands at $1.20.
Francesco Pesole, FX Strategist at Dutch bank ING, said the EUR/USD rate would become even more dependent on the dollar in the near future, with a potential retreat to $1.06 on the cards closer to the Fed meeting next week:
“With a full 25bp hike already in the price by year-end, the ECB had to move away from dovish language to support the euro, while quite the opposite happened. We think that at this stage EUR/USD will revert to being even more driven by the dollar leg. Markets have taken on board the notion that the ECB has likely peaked, meaning that data releases in the eurozone should lose some degree of market relevance. Lagarde has probably switched from a near-term hawkish narrative to defending a higher-for-longer approach to combat inflation: expect some pushback against rate cut speculation if eurozone data deteriorate further. On the other hand, another Fed hike isn’t fully to be ruled out (although it is not our base case) and markets have had to reprice Fed rate cut expectations quite substantially of late on the back of resilient US economic data. Expect EUR:USD short-term rate differentials to be an even closer function of US activity prints from now on. We could see EUR/USD inch back higher today, but a return to the 1.0600/1.0650 area around the Fed meeting seems appropriate.”
Analysts at Danske Bank continued to forecast a lower euro to dollar exchange rate following yesterday’s ECB meeting, seeing it potentially trade at $1.03 in 12 months’ time:
“The dovish hike from the ECB and ongoing US outperformance are weighing on the cross. We make no changes to our EUR/USD forecast, and hence we maintain our strategic case for a lower EUR/USD based on relative terms of trade, real rates and relative unit labour costs. We expect the relative strength of the US economy to continue weighing on the EUR/USD in the coming months as growth differentials take the driver’s seat, and we continue to forecast the cross at 1.06/1.03 in 6/12M. As it is hard to imagine a sudden change of the current USD momentum, and with commodity prices currently rising, we may reach our 6M forecast for the cross earlier than expected.”
Markets will be watching ECB President Christine Lagarde’s speech at the Eurogroup meeting today, as well as Eurostat’s release of Q2 labor costs and trade balance figures.
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