The Euro failed to capitalize on better than expected data from the Eurozone in yesterday’s trading session, and fell around 100 points against the US dollar which is probably a clear sign that market participants are focused on developments in the US rather than local matters.
To kick off the day, we saw the release of Germany’s ZEW Economic Sentiment Index which hit the market at a whopping 51.7, much higher than last months figure of 29.9 and well above analysts’ expectations for a figure of 32.0. The Eurozone Economic Sentiment Index was equally impressive jumping from 26.8 to 49.4 and was also well above predictions for a figure of 29.2.
Despite the good news, the Euro was heavily sold off as traders took positions in the greenback ahead of a possible rate hike from the US Federal Reserve as early as next month to counter rising inflation which is at its highest level in 40 years.
Europe is also dealing with record inflation figures which are currently running at 5% but so far the European Central Bank has resisted calls to set the stage for a possible rate hike this year because they firmly believe the current inflation figures are only temporary and will subside as the year unfolds.
Not everybody, however, agrees with the ECB’s position and some believe if the Central Bank waits too long to reign in inflation there will be long term consequences for the Euro and the Eurozone as a whole.
"Zero and negative interest rates respectively are pure emergency measures. With inflation above target and inflation risks tilted to the upside as well as a tight labour market and a closed output gap there is no reason to keep rates that low," said Jörg Angelé, a senior economist from Bantleon Bank.
"It would be better for the ECB to start early reversing its ultraloose monetary policy in small steps. If it waits too long, it risks being forced to pull the brakes and end up with a recession" he added.
As we can see on the chart, the EUR/USD currency pair has broken down through the resistance level of $1.1352 and back into the consolidation channel where it was previously stuck for around 2 months and it has also taken out the 50 day EMA.
As mentioned earlier, interest rate talk is going to be the main driver of the EUR/USD currency pair and the best case scenario as it stands may see the ECB begin cutting its monthly asset purchases in the 2nd quarter of this year which could be followed by an interest rate hike in the first quarter 2023.
This still leaves the ECB way behind many other central banks such as the US Federal Reserve who are on the verge of raising rates and the Bank of England who have already tightened monetary policy which leaves the Euro looking like an unattractive bet with no yield and may lead to further losses.