Euro surges as ECB hikes rates

Important calendar events

• BOJ Policy Rate, Monetary Policy Statement, BOJ Press Conference
• GBP: Consumer Inflation Expectations
• EUR: Final CPI, Final Core CPI, Italian Trade Balance, ECOFIN Meetings
• USD: Preliminary UoM Consumer Sentiment, Preliminary UoM Inflation Expectations

USD

The dollar plummeted on Thursday, as markets began to digest Wednesday’s Fed rate decision, with the dollar index dropping to 102.1. US Treasury yields also dipped, with the US 10-year bond yield dropping to 3.72%.

US economic activity data released on Thursday were overall mixed, failing to provide support for the dollar. The Empire State Manufacturing Index rose to 6.6 in June from -31.8 in May, with a positive print indicating growing optimism in the manufacturing sector. US Retail Sales rose by 0.3% in May, dropping from a 0.4% rise in April, but exceeding expectations of a 0.2% decline. Core Retail sales, on the other hand, which exclude automobiles, grew by 0.1% in May in line with expectations, registering a significant drop from April’s 0.4% growth.  

The U.S. Federal Reserve kept its interest rate steady at its policy meeting on Wednesday for the first time in well over a year. Fed officials have voted to keep the central bank’s interest rate at a target range of 5.00% to 5.25%. 

The Fed signaled on Wednesday, however, that its tightening cycle is not over yet and that its peak rate might be higher than anticipated. The FOMC policy statement following the conclusion of the meeting was hawkish, hinting at further rate hikes. The purpose of suspending rate hikes is to give policymakers time to assess the pace of cooling inflation and many economists believe that the Fed may resume rate hikes as early as July if inflation remains sticky. The Fed warned that additional firming may be appropriate. US Federal Reserve Chair Jerome Powell has also warned that the labor market remains very tight. 

US Headline inflation dropped sharply to 4.0% year-on-year in May, from 4.9% in April. US Inflation cooled more than expected in May, as markets were anticipating a 4.1% print. Core CPI, on the other hand, which excludes food and energy, remained sticky at 0.4% every month and 5.3% on an annual basis. US headline inflation dropped to its lowest point since March 2021 after 12 consecutive months of declines. Easing inflation enhances the odds of a pause in rate hikes at Wednesday’s Fed meeting.

US Producer Price Index data released on Wednesday confirmed that US inflation is starting to ease. PPI declined by 0.3% in May, against expectations of a 0.1% drop and a 0.2% growth in April. Annual PPI dropped from 2.3% to 1.1%, while core PPI fell from 3.2% to 2.8% year-on-year, beating estimates of 2.9%.

The US economy expanded by 1.3% in the first year of 2023 against predictions of a 1.1% growth. The preliminary GDP Price Index, which is an important inflation gauge, exceeded expectations, rising by 4.2% in Q1 of 2023 versus the 4.0% anticipated. 

US Preliminary UoM Consumer Sentiment and Preliminary UoM Inflation Expectations on Friday may affect the dollar in the wake of Wednesday’s Fed meeting. 

TRADE USD PAIRS

EUR 

The Euro gained strength against the dollar after the ECB rate decision on Thursday, with EUR/USD touching the 1.095 level. If the currency pair goes up, it may encounter resistance near 1.100. If the EUR/USD pair declines, it may find support at 1.067. 

The ECB raised interest rates by 25 bp on Thursday, bringing its main refinancing rate to 4.00%. The ECB has signaled that further rate hikes are required as inflationary pressures in the EU remain high. The ECB revised upwards its inflation forecasts for 2023, 2024, and 2025 by one-tenth of a percent, to 5.4%, 3.0%, and 2.2%, respectively. Higher inflation projections raised expectations for additional monetary tightening. 

ECB President Christine Lagarde delivered a hawkish press conference following the policy meeting, pointing to further rate hikes. Lagarde hinted that another rate hike in July is likely as inflation in the Eurozone is sticky. Lagarde’s comments point to further rate hikes up ahead, while the US Fed has signaled a pause in rate hikes.

Headline inflation in the Eurozone cooled to 6.1% year-on-year in May from 7.0% in April, beating expectations of 6.3%. Core Inflation, which excludes food and energy, also slowed to 5.3% on an annual basis in May versus 5.6% in April and 5.5% forecast. The latest inflation print is showing that the ECB’s efforts to bring inflation down are paying off, but it will likely not be sufficient to induce the central bank to abandon its hawkish policy just yet.

GDP data for the first quarter of the year showed that the Eurozone is technically entering a recession. Revised GDP showed a contraction of 0.1% for Q1 of 2023, in contrast to the Flash GDP data released earlier which showed an expansion of 0.1%. Deteriorating economic conditions in the Eurozone may force the ECB to rethink its hawkish monetary policy. 

Several important economic activity indicators are scheduled to be released on Friday for the Eurozone, especially Final CPI and Final Core CPI. These may cause some volatility in the Euro price in the wake of Thursday’s ECB meeting. 

TRADE EUR PAIRS

GBP 

The Sterling gained strength against the dollar on Thursday, with GBP/USD rising to 1.278. If the GBP/USD rate goes up, it may encounter resistance near 1.300, while support may be found near 1.236. 

Upbeat economic GDP data boosted the Sterling on Wednesday. GDP data showed that Britain’s economy expanded by 0.2% month-on-month in April after a contraction of 0.3% in March. GDP grew by 0.1% for the 3-month figure to April pointing to slow growth and cooling recession concerns. In addition, the Services sector pushed higher by 0.3% in April after a fall of 0.5% in March. Construction Output, however, contracted by 0.6% in April against a 0.2% growth in March. Industrial and Manufacturing Production both declined by 0.3% every month in April, dropping below expectations of a 0.1% decline. 

A climate of political instability pushed the Sterling down this week. Former Prime Minister Boris Johnson and two fellow lawmakers resigned over the weekend. The ongoing feud between the former PM and the current PM Rishi Sunak has put pressure on Sterling.

The BOE is expected to increase interest rates in the coming months as it fights to bring inflation down. BOE governor Andrew Bailey has warned that inflation in the UK is persistent and will require further tightening to get inflation to target. Bailey stated on Tuesday, that inflation is taking longer to come down than anticipated, increasing market odds of future rate hikes.

The BOE raised interest rates by 25 basis points at its latest meeting in May, bringing the bank rate to 4.5%. Market odds are in favor of more BOE rate hikes up ahead and many analysts predict no rate cuts at all within the year. The BOE has been following an aggressively hawkish monetary policy, aiming to bring inflation down. As the US has signaled a pause in rate hikes, BOE interest rates may soon catch up with Fed rates, boosting the Sterling.

The UK’s weak economic outlook limits policymakers’ ability to increase interest rates sufficiently to rein in inflation. The British economy is struggling, and policymakers will have to assess how much tightening it can withstand to bring inflation down.

Headline inflation in the UK dropped below 10% on an annual basis in April for the first time since August 2022. Inflation in the UK is starting to cool, although not as rapidly as anticipated. Headline inflation rose by 8.7% year-on-year in April from 10.1% in March, surpassing expectations of 8.2%. Core CPI, which excludes food and energy, however, rose to 6.8% on an annual basis in April from 6.2% in March.

TRADE GBP PAIRS

JPY

The USD/JPY was catapulted to 141.1 in early trading on Thursday but pared some of its gains later in the day. If the USD/JPY pair declines, it may find support near 138.5. If the pair climbs, it may find resistance at 142.2. 

Economic activity indicators released on Thursday for Japan were overall positive, providing support for the Yen. Core Machinery Orders rose by 5.5% in April against a 3.9% drop in March, exceeding expectations of a 3.1% growth. Tertiary Industry Activity expanded by 1.2% in April versus a 1.5% contraction in March and expectations of a 0.5% growth. 

The BOJ is holding its monetary policy meeting on Friday. The BOJ maintained its dovish monetary policy at the bank’s previous meeting in April. This was the first meeting with the newly-appointed BOJ Governor Kazuo Ueda at the helm. Ueda has stated that monetary policy would remain accommodative until the bank’s 2% inflation target became sustainable. He also predicted that price pressures would fall sharply in the next year.

Japanese policymakers are expected to maintain the bank’s ultra-low interest rates on Friday, keeping the central bank’s refinancing rate at -0.10%. The BOJ is also not expected to make any adjustments to its yield curve control program. The BOJ Monetary Policy Statement and Governor Ueda’s post-meeting news conference are expected to attract traders’ attention. Japanese policymakers may take into account rising inflation rates. Increased price pressures raise the chance of the BOJ upgrading its inflation forecast in July, which may lay the groundwork for a change in policy down the road.

BOJ Core CPI rose to 3.0% year-on-year in April from 2.9% in March. April’s print exceeded expectations of a 2.8% growth, indicating that price pressures in Japan continue to rise. Tokyo Core CPI for April was also hotter than expected, at 3.5% on an annual basis, against expectations of a 3.2% print. Inflation in Japan remains steadily above the BOJ’s 2% target, putting pressure on businesses and households. 

Final GDP data for the year's first quarter released last week showed that the Japanese economy expanded by 0.7%, against a preliminary GDP print of 0.4%. The GDP data exceeded expectations, alleviating recession concerns for Japan. The final GDP Price Index printed showed a 2.0% annual expansion, versus 1.2% the previous quarter. Japan’s economic recovery increases the odds of a hawkish pivot in BOJ’s monetary policy.

TRADE JPY PAIRS

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Written by:
Myrsini Giannouli

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