Into the end of last year, the idea of central banks pivoting away from aggressive tightening campaigns was one of the main market themes.
With inflation seen slipping back across the board, traders were anticipating a slower pace of tightening from key central banks such as the Fed and the ECB. The Fed, which began pivoting on rates before the end of the year was seen as the key bellwether for the shift in central bank expectations. Consequently, traders began anticipating a similar slowdown on rates to come from the ECB over the start of this year.
While the ECB has yet to pivot on rates, the recent decline in EURUSD suggests that traders are leaning more in the direction of expecting such action from the bank. At the February ECB meeting, the bank hiked rates by 50bps and signalled a further 50 bps hike to come in March. However, beyond March the bank noted that further rate adjustments would be data dependent. Clearly, traders interpreted these comments with a dovish skew given the declines we’ve seen in EURUSD.
Will ECB pivot after March?
So, looking ahead now, traders are questioning what sort of approach we are likely to see from the ECB and how this will impact EUR. Mainly, traders are wondering whether the bank will indeed pivot on rates after the next 50 bps hike this month or if it will continue with aggressive tightening beyond this month.
Eurozone core inflation rises in February
The first issue to consider is that of inflation. After eurozone inflation cooled in January, feeding into the idea that the ECB would look to pivot on rates beyond March, CPI was seen bouncing back in February. Year-on-year, headline CPI fell from 8.6% to 8.5%, though core inflation was seen moving higher to 5.6% from 5.3%. To this core reading in perspective, February 2022 core CPI was just 2.7%, around half of this year’s print.
Lagarde says inflation still too high
The data has fuelled a fresh rally in EUR against most major trading counterparts, turning sentiment back in favour of a further aggressive action from the ECB beyond this month. This perspective was further endorsed through comments made this week by ECB chief Lagarde. Speaking at a WTO event, Lagarde warned that the ECB expects inflation to stay high in the near-term, adding that the ECB must do more to bring prices down given that the eurozone economy has held up better than expected, keeping upward price pressures in place.
Holzmann calls for 2% more worth of hikes
Lagarde’s comments come fresh on the back of calls from ECB member Robert Holzmann for four more 50 basis point increases from the bank this year. The head of the Austrian central bank said that he expects inflation to stay at elevated levels for a very long time, requiring the ECB to take further aggressive action.
Eurozone yields rising
On the back of these ECB comments this week, eurozone short-date government bond yields were seen rising further, hitting their highest levels in 14 years. The market is currently pricing in peak ECB rates of 4%. However, with inflation proving stickier than expected, these projections could well be revised higher this month if the ECB delivers a more hawkish outlook at the March meeting.
Upside risks for EUR
In light of the latest inflation data and the comments we’ve heard from the ECB, EUR risks look skewed to the upside heading into the meeting. With Lagarde likely to try and avoid the fate of the EUR at the last meeting (selling off upon mention of data-dependent moves), EUR should see a fresh wave of demand taking the currency higher across the board into Q2 and beyond. Following the March meeting, incoming inflation data will be the key to assessing the likely path of the Euro. While inflation data remains sticky, higher rate projections will remain appropriate, keeping EUR supported. However, should we see any material drop in inflation in coming months this will likely see EUR come off as traders once again begin to anticipate an ECB pivot.
EURUSD weekly technical chart
Source: TradingView / FlowBank
The recovery rally in EURUSD stalled into a test of 1.0971 level. Price has since corrected lower within the bull channel from last year’s lows and is currently sitting on support at the 1.0530 level, just above the channel support line. While this area holds, the outlook remains bullish in favour of another move higher within the channel. However, should the current lows break, 1.0356 will be the next support area to monitor.
