EUR/USD expects sharp ECB rate hike amid threat of recession

Fundamental outlook for the euro: neutral

• Euro the best week since the end of May after less violent Fedspeak
• EUR/USD could enjoy the most aggressive ECB tightening in history
• But key US economic data will also vie for his attention

The euro rose against 1.4 percent US dollar last week, marking its best 5-day stretch since late May. EURO/USD could thank less hawkish speeches by members of the Federal Reserve on Friday. It came as policymakers entered a shutdown period, giving markets some interesting commentary to digest before the central bank’s next interest rate announcement in November.

But it’s not in a couple of weeks. The focus for EUR/USD is on the European Central Bank, which sets interest rates on Thursday. As inflation continues to wreak havoc on the eurozone, the ECB continues its most aggressive tightening cycle in its history. Policymakers are expected to raise the main refinancing rate and deposit rate by 75 basis points to 2% and 1.5%, respectively.

This is greatly appreciated. Unless unexpected, the adjustments themselves are likely to have little effect on the euro. Then all eyes will be switched to what could be in December. Looking at market prices, the ECB raised rates by 50 basis points at the end of 2022. There is about a 50% chance that another 25 basis points could be added on top of that.

So if ECB President Christine Lagarde continues to insist on tackling inflation, another 75 basis point hike in December could bode well for the euro. Markets are also interested in more details on when quantitative tightening may begin. Although, it does not seem likely that a specific date can be proposed.

Policymakers are also pushing for more tightening despite growing fears of a recession in the eurozone economy. Preliminary German GDP data for the third quarter will be released on Friday, likely showing a significant slowdown from the second quarter. Meanwhile, data on inflation in Germany will also cross the wires. CPI in October was 10.1% y/y.

Euro traders should also pay attention to data from the US. A strong Q3 GDP print is expected on Thursday. This will be followed on Friday by the Fed’s preferred gauge of inflation, PCE core. Therefore, the possibility that this data will undermine the less hawkish Fedspeak noted earlier could lead to a higher USD at the expense of market sentiment. This leaves the fundamental outlook for the euro neutral.

The main drivers of the euro

Data source is TradingView

— Posted by Daniel Dubrowski, DailyFX.com strategist

To contact Daniel, use the comment section below or@ddubrovskyFXon Twitter