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20.01.2023 03:47 PM
EUR/USD. Dovish rumors around the ECB

Despite repeated attempts by EUR/USD sellers to push the market below the mark of 1.0800, the euro/dollar pair is still trading in the eighth figure. Interestingly, the pair fell at the beginning of this week despite a positive report from the ZEW Institute. For instance, despite predictions that it would reach -14 points (and instead rose to +16), the indicator of sentiment in the German business climate for the first time since February of last year came in above zero. Trading nonetheless disregarded this release. Additionally, sellers updated the bottom of the week, marking 1.0775 against the backdrop of extremely positive signs.

The "dovish" rumors

The US dollar index, which displayed upward dynamics on Tuesday and Wednesday and reached a local maximum of 102.66, was the main driver of the downward trend. However, the euro also played a role in the decline of the EUR/USD exchange rate.

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The market has been flooded with reports that the European Central Bank may lower the rate of the interest rate increase to 25 basis points beginning with the March meeting. Bloomberg was the source of the pertinent rumors, and its journalists cited unidentified insiders in the Central Bank camp. Although unofficial, this information served as a "cold shower" for traders of the EUR/USD. The truth is that ECB officials have recently made only hawkish remarks in the public sphere. In an interview with the Financial Times on Monday, Philip Lane, the top economist at the European Central Bank, stated that "interest rates should be substantially higher than they are at present." Other officials of the European regulator, in particular Martins Kazaks, Isabel Schnabel, Robert Holtzman, Olli Rehn, and Francois Villeroy de Galhau, had already made similar points.

The question arose – how representative are the individual views of the above-mentioned ECB representatives? The doubts that arose did not reverse the situation for the pair towards the south, but at the same time, they extinguished the northern ambitions of EUR/USD buyers. The upper border of the Kumo cloud, which coincided with the upper line of the Bollinger Bands on the D1 timeframe, was the closest northern goal, but it was out of reach as traders took profits when the pair reached the resistance level of 1.0890 (the upper line of the Bollinger Bands on the daily chart).

The European Central Bank was able to prevent the pair from sliding into the region of the seventh price level and below, although the ninth number was inaccessible. Due to several fundamental considerations, the price stayed within the eighth figure.

Lagarde, weak reports from the US, and the ECB protocol

First, there were some poor macroeconomic figures released in the US: the indices for retail trade and industrial production had a downward trend and reached a negative area. The most significant measure of inflation, the producer price index, also showed signs of being in the danger zone. It fell short of the anticipated levels and revealed a further slowing in US inflation.

Second, Christine Lagarde, the president of the ECB, supported the euro with "strong artillery." The ECB will continue to actively hike rates to "lower it to a 2 percent target level promptly," she stated yesterday at the World Economic Forum in Davos. She claimed that inflation in the European region is still too high and that inflation expectations are not declining.

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Additionally, the ECB's December meeting minutes were released yesterday. This document astonished me with its hawkish stance as well. A "substantial number" of ECB members initially spoke in favor of increasing the ECB's benchmark interest rates by 75 basis points, the protocol's wording said. An increase in rates of less than 75 basis points, in the opinion of those who favor this choice, "may serve as a misleading signal and may be seen as a mismatch with the target inflation rate." But the "vast majority" of Council members backed Philip Lane's plan to increase benchmark interest rates by 50 basis points.

The way the sentence is phrased in this case is crucial; the fact that a "large number" of ECB members supported raising interest rates by 75 basis points at the December meeting but not "overwhelmingly" shows that hawkish sentiment predominates among them. It is also important to keep in mind that the ECB meeting was held before the eurozone's December inflation growth statistics were released. The core CPI increased once more, to the astonishment of most observers, reaching 5.2%, while the overall consumer price index continued to slow down (another historical record for the eurozone).

Since it became obvious that a significant price increase affects more than only energy and raw materials, this is a very worrying signal for the ECB (for instance, both general and core inflation are slowing down synchronously in the United States). Particularly in the market, they began discussing the "second-order effect," when a wage rise causes inflation to continue to unwind in a price-salary spiral.

The ECB protocol's rhetorical tenor and Christine Lagarde's indications indicate that the European regulator's members are still primarily in a hawkish frame of mind. The European Central Bank will likely increase interest rates by 50 basis points in both February and March (announcing similar March intentions at the next meeting).

All of this shows that the behavior (weakening) of the dollar is now the only factor influencing the northern prospects of the EUR/USD. The "assault" of Bloomberg insiders was resisted by the euro, due to rhetorical "blows" of retaliation from Lagarde and other hawkish ECB officials. The pair's major developments are going to happen the following week; in the medium term, the price of the pair is expected to vary between 1.0780 and 1.0890. As a result, it is wise to think about taking both short and long positions on the pair when the northern and southern impulses wane in the vicinity of the relevant price level bounds.

Irina Manzenko,
Analytical expert of InstaForex
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