EUR/USD pause before a new rally

01/20/2023

2 minutes read

2023.01.20 13:10

The euro has continued to have a very quiet week, trading around the 1.08 level.

It’s hard to imagine ECB President Lagarde as a hawk because she ignored the eurozone’s rise for a long time and claimed it was temporary. As a result of being late to the global tightening party, the ECB rushed to reduce inflation. The new Lagarde has become more hawkish and has not hesitated to make bold statements, such as cautioning the markets against underestimating the ECB’s rate policy.

This week, Lagarde delivered her hawkish message to Davos, stating that inflation remains “way too high” and that the ECB will continue its policy until inflation reaches 2%. That looks like it will take a long time given that inflation is currently at 9.2%.

In February, the European Central Bank is expected to raise rates by 50 basis points, but what happens after that is unknown. Despite the war in Ukraine, the economy of the eurozone is doing reasonably well. A warm winter and efforts to diversify seem to have stopped the feared energy crisis.

The question that needs to be answered moving forward is whether the ECB will respond to the favorable economic environment by increasing interest rates by 25 basis points or 50 basis points to prevent inflation from becoming ingrained. In December, Lagarde stated that the Bank would base future rate changes on data and that additional 50-bp increases might have occurred after February. The markets are unsure of what will happen at the March meeting because ECB members disagree on the subject.

Today marks the beginning of a two-week blackout period by the Federal Reserve ahead of the rate meeting on February 1. As a result, Fed officials’ public statements and interviews will be severely restricted. Thursday, Fed member Brainard reiterated the Fed’s hawkish stance.

Despite indications that inflation was beginning to ease, Brainard stated that interest rates needed to remain high. The markets have priced a peak at around 4.75 percent, while the Fed dot plot predicts that rates will peak at 5.1%. Later today, members of the Fed Harker and Waller will speak to us.