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Euro muddied the waters

Relevance up to 08:00 2022-07-27 UTC–4

The pack leader always points the way. Central banks are following the Federal Reserve, and the intention of Fed Chairman Jerome Powell and his colleagues to quickly bring the economy into recession in order to return inflation to the 2% target is becoming a global trend. On July 21, the European Central Bank joined the club of eight dozen central banks tightening monetary policy, raising the deposit rate by 50 bp. True, this did not help EURUSD. After a slight growth, the pair rushed down, and weak statistics on business activity only accelerated the pace.

Amid the energy crisis and Russia’s intentions to use gas as a weapon against the European Union, it will hardly surprise anyone if the eurozone is already facing an economic downturn. The collapse of the composite purchasing managers index to a 17-month low, and its German counterpart to a 25-month low, indicate a recession. Both indicators were below the critical level of 50, signaling a reduction in GDP.

Dynamics of European business activity

Deteriorating before the eyes of macroeconomic statistics may limit the ECB’s ability to tighten monetary policy. Especially since Christine Lagarde and her colleagues have abandoned forward-looking guidance, considering it counterproductive in the face of uncertainty. Indeed, why insist on raising the rate by 25 bp and then raising it by 50 bp? The Governing Council will make adjustments to monetary policy from meeting to meeting, and if the eurozone finds itself in a recession, a pause in the process of increasing borrowing costs is inevitable. Will investors regard it as a repeat of the stories of 2008 and 2011, when the ECB was forced to cut them after raising rates?

Despite the fact that the futures market still believes in a 50 bp increase in loan costs in September and by 130 bp before the end of the year, these numbers are more likely to fall than rise. The ECB is regularly wrong about inflation forecasts, which are accelerating faster than the central bank suggests, but you also need to consider the recession in the eurozone and the political crisis in Italy.

Forecasts and actual dynamics of European inflation

Thus, the ECB rather muddied the water than clarified something, that in the face of the Fed’s determination, it increases the risks of EURUSD returning to parity. According to ING, amid the current differential in interest rates in the US and the eurozone, such a scenario is more likely than a rally in the main currency pair towards 1.04. Wells Fargo believes that the increase in borrowing costs by the ECB reduces the speed of the euro’s fall, but does not cancel the peak in the direction of $0.95. Much will depend on the Fed’s rhetoric at the July 26-27 meeting.

Technically, on the EURUSD daily chart, a fall below the reference level at 1.012 could lead to both a recovery of the downward trend and the formation of a 1-2-3 reversal pattern. In this case, point 3, most likely, will be located in the range of 1.000-1.002. We sell the pair if it fails to return above the fair value at 1.018.

*The market analysis posted here is meant to increase your awareness, but not to give instructions to make a trade.

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