ECB's Dovish Rate Hike of 25 Basis Points: How Will the Future Trend of Euro/USD Be?

Last week (7/24-7/28), the US dollar index rose by 0.6%, the euro depreciated by approximately 1%, and the yen increased by 0.5%.

【Source: MacroMicro  Date2023/7/24-2023/7/28】

【Source: MacroMicro   Date2023/1/1-2023/7/28】

On July 27th, the European Central Bank (ECB) increased interest rates by 25 basis points as planned and stated its commitment to maintaining rates at a sufficiently restrictive level when necessary. ECB President Lagarde expressed openness towards decisions in September and beyond, indicating that there could be a rate hike or a pause, but ruled out a rate cut. This statement was perceived as dovish by the market.

Following the meeting, the euro plummeted against the US dollar, compounded by PMI data released on the 24th falling short of expectations, resulting in a nearly 1% decline in the EUR/USD pair last week.

The future direction of the EUR/USD will depend primarily on economic data and monetary policy divergences between Europe and the United States. Given that core inflationary pressures in the Eurozone still outweigh those in the US, market expectations for a rate hike by the ECB in September remain stronger than those for the Federal Reserve. In the medium term, this will provide some support for the euro.

According to the latest data, the Eurozone's harmonized CPI rose by 5.3% year-on-year in July, in line with expectations. Excluding volatile food and energy prices, the Eurozone's core harmonized CPI increased by 5.5% year-on-year, surpassing the anticipated 5.4%, indicating persistent inflation.

【Source：MacroMicro 】

Mitrade Analyst：

Due to weak economic data in the Eurozone and dovish statements from Lagarde, market expectations for a rate hike by the European Central Bank (ECB) have gradually weakened. However, inflation data still supports further tightening. Attention is focused on the interest rate decision by the Bank of England (BOE) this Thursday. If the BOE adopts a hawkish stance and raises rates, it could boost GBP/USD and also potentially benefit EUR/USD.

From a technical perspective, EUR/USD has fallen below the 21-day moving average, increasing the probability of a short-term rebound. Resistance is seen at 1.11, while support is seen at 1.09.

【Source：TradingView】

On July 28th, the Bank of Japan announced its latest interest rate decision. The key short-term interest rate remained unchanged at -0.1%, and the target range for the 10-year Japanese government bond yield was maintained at ±0.5%, but there were changes in wording. The Bank of Japan stated that these upper and lower limits are only reference points and it will exercise more flexibility in control. The Bank plans to purchase 10-year Japanese government bonds at a fixed rate of 1%, which is higher than the previous 0.5%.

This means that the Bank of Japan is now willing to tolerate a rise in the 10-year government bond yield to 1.0%, and the "new upper limit" for bond yields is set at 1%. Some investors view this as a prelude to the eventual exit from large-scale monetary stimulus.

Following the announcement, the yen strengthened during trading, but Bank of Japan Governor Haruhiko Kuroda later stated that adjusting the Yield Curve Control (YCC) does not change the Bank's accommodative stance, causing the yen to fluctuate and eventually decline.

Some institutions believe that this meeting actually signaled a dovish stance, with the dovish signal hidden in the inflation forecast for next year.

In the updated inflation forecast released last Friday, members of the Bank of Japan's Monetary Policy Committee significantly raised the median CPI forecast for the fiscal year 2023 from 1.8% in April to 2.5%. However, the median CPI forecast for the fiscal year 2024 was lowered from 2% in April to 1.9%, falling below the Bank of Japan's target.

【Source：Bloomberg】

Mitrade Analyst：

The adjustment of yield curve control (YCC) will not directly lead to an increase in key short-term interest rates (-0.1%). Given that the tightening cycles in the United States and Europe seem to have entered their final stages, there is less upward pressure on interest rates. Therefore, we believe the likelihood of significant adjustments to monetary policy by the Bank of Japan in the medium term (one quarter) is low. However, in the long term, there is a possibility of normalization by the Bank of Japan, and we maintain a bullish outlook on the yen.

From a technical perspective, USD/JPY has surpassed the key level of 141 and is currently above the 21-day moving average, suggesting that it will likely experience range-bound volatility in the short term. Resistance is seen at 145, while support is seen at 138.

【Source：TradingView】