Analysts say the single currency is under pressure not from monetary policy, but from the intertwined threats of recession and power cuts in Russia. Such dynamics are unfavorable for the European Central Bank, even if it resorts to excessive measures to increase the cost of borrowing, which were recently adopted by the Federal Reserve.
"Rates have not been a driving force in the currency markets, especially last month - in fact it is due to the dynamics of global growth," said Samuel Zief, head of global currency strategy at JPMorgan Private Bank. - A significant increase in rates does not support the currency when it is being done to support inflationary expectations while at the same time worsening growth prospects."
Facing the fastest inflation since the introduction of the euro, the European Central Bank last month raised the cost of borrowing for the first time in more than a decade, raising the deposit rate by half a point to 0%.
While investors expect another such move on September 8, storm clouds are gathering over the economies of the 19 eurozone countries as the cost-of-living crisis and fighting in Ukraine put pressure on households and businesses.
S&P Global surveys released Tuesday showed business activity contracting for a second month, with the post-pandemic recovery in areas like tourism all but halting. Meanwhile, a weaker euro, which hit a 20-year low against the dollar this week, is boosting inflation by making imports more expensive, a cause for particular concern as much of the region's inflation is fueled by mostly dollar-denominated energy commodities.
The gloomy backdrop means that even an unprecedented three-quarter-point rate hike won't push the euro much higher, said Dirk Schumacher, an economist at Natixis in Frankfurt.
"Choosing 75 basis points instead of 50 won't change much," he said. "You need a minimum of positive economic prospects to significantly affect the exchange rate with interest rate changes alone."
Asked if a bigger hike makes sense in the context of a falling euro, Jorg Kramer, chief economist at Commerzbank AG, said such a move "would probably be a good idea given the inflation outlook." While he doesn't rule out such an outcome, he said he "doesn't believe the ECB would go for it."
Indeed, ECB executive board member Fabio Panetta on Tuesday called for prudence in planning next steps as the prospect of a downturn in the euro area becomes increasingly likely.
"If we have a significant slowdown or even a recession, that will alleviate inflationary pressures," he said at a panel discussion in Milan.
Money markets have priced in a half-point increase next month and placed a 20% rate at 75 basis points. Beyond that, traders are betting on a 130 basis point tightening by the end of the year, with the deposit rate eventually rising to 2% by September 2023.
Germany, Europe's largest economy, is a particularly weak spot as the government struggles to replace natural gas imports from Russia and rising prices threaten the country's critical manufacturing sector.
According to Marco Valli, chief European economist at UniCredit, issues like these are likely to sway policy makers for another 50 basis points hike.
"The ECB will go for a half-point rate hike in September – that would be a big surprise and actually a mistake," he said. "The exchange rate pretty much reflects the problems the eurozone is facing right now."
