The European Central Bank's move was not a hawkish surprise.
The ECB has increased the deposit rate by unprecedented 75 basis points to 1.25%, the highest rate since 2011. The move matched forecasts by Bloomberg, and earlier the markets priced in an 80% probability of such an increase. If the move turned out to be lower that expected, then EUR/USD would be hit by another sell-off. However, bears have not lost control of the situation.
The ECB has reasonably adjusted its outlooks as well. The Eurozone's baseline GDP outlook for 2022 has been increased to 3.1%, but the 2023 outlook was decreased to 0.9%. Inflation is now forecast to reach 5.5% in 2023, well above 3.5% expected earlier, and would remain above the target level of 2%. The ECB is now expected to begin a monetary tightening cycle, which in theory should give support to the euro. In addition, the EU regulator does not expect a recession to begin in the future, unlike the Bank of England.
ECB's outlooks on GDP and inflation
The ECB's position is rather optimistic – the regulator expects that rate hikes would slow down inflationary expectations and then reduce price growth. Unfortunately, inflation in the eurozone has been driven by a rally in the energy market, and the ECB cannot influence energy prices.
Christine Lagarde's remarks about how the ECB is determined to push down inflation and how policymakers unanimously agreed on the hike have failed to impress market players. Only a more significant hawkish surprise move could have kept EUR/USD above parity, and Lagarde's actions fell short of that.
EUR/USD's performance and the yield spread of US and German sovereign bonds
EUR/USD's performance is determined by the yield spread of US and German sovereign bonds. As inflation in the United States slows down, interest rates on debt there will rise. On the other hand, in Europe inflation has not yet peaked, and yield growth should outpace it.
The EUR/USD downtrend continues, despite the ECB being dissatisfied by the weaker euro. Bears withstood the challenge presented by the ECB policy meeting. At the same time, they face a new test – a possible rally of US stock indexes amid expectations of slower consumer price growth in the US. It appears that EUR could very well hit 0.97 per dollar in the near future.
EUR/USD bulls have been unable to settle above the parity level on the daily chart. As a result, traders are recommended to go short on the pair, while it remains below 1, with 0.97 being the target.
