EUR/USD exchange rate will continue to rise despite improvements in core inflation dynamics
Invezz.com – One of the most important economic data for the euro area was released this week. On Wednesday, the annual CPI Final data showed inflation in the euro area at 6.9%.
Luxembourg and Spain registered the smallest increases, of 2.9%, respectively 3.1%. While the 6.9% average for the euro area is well above the European Central Bank’s (ECB) target of 2%, it is still well below inflation levels seen in other parts of the world. For example, inflation in the UK remains in double-digit territory.
In other words, it depends on what one wants to read from this week’s data. Indeed, the prices of goods and services in the euro area increased faster than the ECB had anticipated.
But some encouraging signs are worth noting.
Median and super core inflation decreased in March
Central banks, including the ECB, prefer to consider inflation measures that exclude volatile food and energy prices. Therefore, core inflation data, as they are called, has more influence on the members of the Governing Council when setting interest rates.
It means that if core inflation stabilizes over the summer, the ECB will stick with 25bp rate hikes instead of 50bp.
So why is this bullish for the rate if the ECB is going to rise less than so far due to improvements in core inflation?
The answer comes from the other side of the Atlantic, as the Fed prepares for a small recession.
Economic indicators point to an economic recession in the US.
The case for a higher EUR/USD rate is based on the possible upcoming divergence between the Fed and the ECB. So far, the Fed has raised the funds rate faster than the ECB.
But economic indicators have recently shown that an economic recession could hit the United States. If that’s the case, the Fed will pause or cut, but the ECB won’t.
For example, the leading economic index has forecast every recession since 1965. It is currently in recession territory, so why would this time be any different? Furthermore, new manufacturing orders have reached dangerously low levels.
Add to this the fact that the Federal Reserve has $300 billion on its balance sheet to support struggling banks. Additionally, tech companies continue to lay off, a sign that has never been a positive for the US economy.
So while improvements in core inflation data in the euro area could trigger minor increases in the key ECB interest rate, the gap with the Fed is about to narrow. A higher EUR/USD rate makes sense under such premises.
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