How far will central banks go to bring inflation under control? Should the ECB act as aggressively as the Fed? Where is the ceiling of interest rates? Let us discuss the Forex outlook and make up a EURUSD trading plan.
Weekly euro fundamental forecast
The economies of the US and the euro area look similar. Both are large and seem to be strong, but their structures are fundamentally different. The US economy is much more overheated than the euro-area one. The US core inflation has hit 6.6%, the highest in 40 years, while the euro-area inflation is 4.8%. At the same time, consumer prices in Europe are higher than in the USA. The rise in the euro-area consumer prices results from gas prices, which are currently lowering, making it easier for the ECB to solve the problem of high inflation. How will this affect the EURUSD?
Suppose domestic demand in the currency bloc is weaker than the American one, and the supply shock due to the war in Ukraine and the energy crisis is much greater. In that case, the European Central Bank must be cautious not to go too far. The effect of tightening monetary policy manifests itself with a time lag. So, the euro-area economy could suffer from tightening financial conditions when inflation is significantly lower.
Dynamics of financial conditions
Source: Financial Times.
Reuters experts predict that the 2.5% ECB deposit rate ceiling is much lower than the federal funds rate. This is not only because the Fed started monetary tightening earlier than the ECB. The Fed must act more aggressively because the US economy is overheated. However, the ECB is expected to act more decisively, in particular, to raise the interest rate by 75 basis points at the October meeting.
Regulators are forced to be aggressive in the short term to anchor inflationary expectations. Still, due to various factors underlying the rise in prices, monetary policy in the euro area will likely remain loose in the long term. As it was before the pandemic.
As for the US, both the market and Bloomberg, expect a significant slowdown in inflation in 2023. Investors, as it were, believe in the Fed’s determination to reduce inflation, but they still hope for a dovish shift. This hope has proved to be wrong many times, but the stock indexes and EURUSD should be corrected up from time to time.
Dynamics of expectations for US inflation
Source: Bloomberg.
Thus, the chances that the ECB will slow down the monetary restriction faster than the Fed are higher since the European Central Bank does not need to raise rates as high as in the US. At the same time, the markets will continue counting on the Fed’s dovish shift, which doesn’t seem wise. All this suggests that the EURUSD downtrend remains strong, but the chances of corrections increase over time.
Weekly EURUSD trading plan
The reasons for the current EURUSD rise are a drop in gas prices, stabilization of the UK financial markets, and the expectations of the ECB rate hike on October 27. If the EURUSD consolidates above 0.985, the profitable strategy will be selling on the rebound from the resistances at 0.989, 0.992, and 0.995.
Price chart of EURUSD in real time mode
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