The EURUSD has dropped because investors started selling the euro on the facts, after buying it on the news. Furthermore, Christine Lagarde vaguely hinted at the ECB’s dovish shift.
Weekly euro fundamental forecast
It’s hard not to think about the ECB’s dovish shift if other central banks are slowing down the pace of monetary restriction. Despite a second consecutive 75-basis-point hike in the deposit rate to 1.5%, the highest since 2009, Christine Lagarde spoke at length about the slowdown in economic activity, noting that the central bank has already made significant progress in reversing the easy money policy. The ECB president implicitly pointed to a dovish shift. Moreover, investors started selling the euro on the facts, after buying on the news. Therefore, the EURUSD fell below parity.
The ECB acted less aggressively than the Fed in 2022 due to the slower recovery of the euro-area economy after the pandemic, the drop in demand amid the war in Ukraine, and, finally, due to political instability in Italy. Now, the ECB is not ready to continue aggressively raising the deposit rate due to the feeling that the euro-area economy has already fallen into recession.
According to a Bloomberg source familiar with the matter, three members of the Governing Council voted to increase borrowing costs by 50 basis points. From the ECB’s accompanying statement, the phrase about raising rates at several subsequent meetings was excluded, which can be regarded as a small victory for the doves.
There is a danger that the ECB will go dovish too soon, undoing all the work it has done so far. However, based on the structure of the euro-area inflation, the ECB can afford to slow down. A drop in gas prices will certainly affect the CPI.
Dynamics of inflation and GDP in euro area
Source: Bloomberg.
Christine Lagarde’s focus on a weaker PMI could give the impression that the ECB is led by the government. Italian Prime Minister Giorgia Meloni called monetary tightening a reckless decision, while French President Emmanuel Macron expressed concern that central banks were destroying demand. In fact, the European regulator is independent in its decisions.
A slowdown in the economy can push the Fed to slow down monetary tightening. One should not be misled by the US GDP growth of 2.6% in July-September. In fact, it is based on the rise in net exports. Despite the robust final figure, if we look deeper, we shall see a slowdown in individual demand from 2.1% in the first quarter to 0.5% in the second and to 0.1% in the third. That is why the technical recession was not recognized by the official NBER, but the recession is approaching.
Dynamics and structure of US GDP
Source: Wall Street Journal.
Weekly EURUSD trading plan
Therefore, the EURUSD trend will depend on the Fed, although the ECB’s willingness to slow down monetary tightening has somehow discouraged the euro bulls. The euro/dollar should be consolidating ahead of the FOMC meeting on November 1-2. I suggest holding down shorts entered at 1.002.
Price chart of EURUSD in real time mode
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