Euro holds steady as traders assess Fed and ECB interest rate paths
- EUR/USD consolidates as traders seek clarity on the Fed and ECB interest rate paths.
- The Greenback remains supported despite signs of a cooling US labor market.
- ECB officials say inflation risks remain despite easing Oil prices.
EUR/USD trades in a narrow range on Tuesday as traders await greater clarity on the Federal Reserve's (Fed) and European Central Bank's (ECB) interest rate paths. At the time of writing, EUR/USD is trading around 1.1436, little changed on the day.
Inflation risks have moderated as Oil prices have fully unwound their US-Iran war-driven rally following last month's interim peace agreement, which reopened shipping through the Strait of Hormuz.
However, policymakers on both sides of the Atlantic continue to signal that monetary policy is likely to remain restrictive in the coming months, with inflation running above their respective 2% targets.
ECB Governing Council member Fabio Panetta said on Tuesday that the "outlook remains fragile," adding that "upside inflation and downside growth risks remain."
ECB Governing Council member Pierre Wunsch said on Monday that "it seems that the Iran shock has disappeared" and that "we haven't seen that many second-round effects." However, he added, "maybe we have to do more, but the situation doesn't ask for significant tightening."
Meanwhile, Fed Governor Christopher Waller reaffirmed on Monday the central bank's commitment to its 2% inflation target, calling it "a credible pledge." He also said, "The risks have flipped around, the labor market seems stabilized, and inflation has been taking off, which changes how you think about policy."
However, recent US labor market data suggest conditions remain fragile despite showing signs of improvement earlier this year. The four-week average of the ADP Employment Change slowed to 21K from 24.25K. This follows last week's disappointing June Nonfarm Payrolls (NFP) report, which showed the US economy added just 57K jobs, well below market expectations of 110K.
A softening labor market, combined with still-sticky inflation, supports the view that the Federal Reserve (Fed) will remain on hold in the near term, keeping the US Dollar (USD) supported. The US Dollar Index (DXY), which tracks the Greenback against a basket of six major currencies, is trading around 100.95.
Traders now await the release of the Federal Open Market Committee (FOMC) meeting minutes on Wednesday for fresh clues on the policy outlook.
ECB FAQs
The European Central Bank (ECB) in Frankfurt, Germany, is the reserve bank for the Eurozone. The ECB sets interest rates and manages monetary policy for the region. The ECB primary mandate is to maintain price stability, which means keeping inflation at around 2%. Its primary tool for achieving this is by raising or lowering interest rates. Relatively high interest rates will usually result in a stronger Euro and vice versa. The ECB Governing Council makes monetary policy decisions at meetings held eight times a year. Decisions are made by heads of the Eurozone national banks and six permanent members, including the President of the ECB, Christine Lagarde.
In extreme situations, the European Central Bank can enact a policy tool called Quantitative Easing. QE is the process by which the ECB prints Euros and uses them to buy assets – usually government or corporate bonds – from banks and other financial institutions. QE usually results in a weaker Euro. QE is a last resort when simply lowering interest rates is unlikely to achieve the objective of price stability. The ECB used it during the Great Financial Crisis in 2009-11, in 2015 when inflation remained stubbornly low, as well as during the covid pandemic.
Quantitative tightening (QT) is the reverse of QE. It is undertaken after QE when an economic recovery is underway and inflation starts rising. Whilst in QE the European Central Bank (ECB) purchases government and corporate bonds from financial institutions to provide them with liquidity, in QT the ECB stops buying more bonds, and stops reinvesting the principal maturing on the bonds it already holds. It is usually positive (or bullish) for the Euro.
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