Euro gains traction above 1.1350 as ECB holds rates steady
- EUR/USD edges higher to around 1.1385 in Friday’s early European session.
- ECB holds rates steady and keeps the door open to more tightening, supporting the Euro.
- The US military launched another night of strikes against Iranian targets.
The EUR/USD pair gathers strength to near 1.1385 during the early European trading hours on Friday, bolstered by the prospect of imminent European Central Bank (ECB) rate hikes. The preliminary readings of the Purchasing Managers Index (PMI) for July from the Eurozone, Germany and the US will be the highlights later on Friday.
As widely expected, the ECB decided to keep the key interest rates unchanged at its July policy meeting on Thursday but held the door open to another rate hike in September, as a surge in energy prices threatened to keep inflation well above its 2% target.
ECB President Christine Lagarde said during a press conference that the central bank anticipates inflation to remain “well above target” until the first half of 2027. Officials remain on high alert for a "second-round inflation shock" triggered by the US-Iran conflict, with markets broadly betting that rate hikes will resume later this year.
Hawkish ECB expectations could provide some support to the Euro (EUR) against the US Dollar (USD) in the near term. Markets are now pricing in around 95% odds of a 25-basis-point ECB rate hike in September and a similar chance of a further move by December, according to Reuters.
The US military carried out a 13th consecutive night of strikes on Iran, targeting drone facilities, coastal surveillance sites and more. US President Donald Trump said on Thursday that the US would hold Iran responsible for the Houthis’ actions and warned Iran and its Houthi allies would both soon receive a “major military punishment,” per the Guardian. Escalating tensions in the Middle East could boost a safe-haven currency such as the Greenback and create a headwind for the major pair.
Eurozone short-end leads as markets price in more hawkish ECB and Fed paths
Analysts at MUFG observe that “in response to rising energy prices, market participants have been moving to price in more hawkish expectations for major central banks including the ECB and Fed resulting in short-term yields rising to fresh year-to-date highs.” They note that “the euro-zone rate market is now pricing in two to three further ECB rate hikes in the year ahead while the US rate market is pricing in around two Fed hikes over the same period.” MUFG adds that “short-term yields have risen more recently in Europe than in the US resulting in yield spreads moving against the USD,” underscoring how the recent repricing has been more pronounced on the Eurozone side of the curve.
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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