The EUR/USD pair maintained steady gains during early North American trading on Monday, supported by a softer US Dollar (USD) and stronger-than-expected Eurozone Gross Domestic Product (GDP) figures. Trading volume is likely to remain light, as US stock and bond markets are closed for the Labor Day holiday. At the time of writing, the pair is trading around 1.1626.
The US Dollar continues to face selling pressure, as a surge in the Japanese Yen (JPY) outweighs support from hawkish Federal Reserve (Fed) expectations and ongoing geopolitical tensions. Consequently, USD/JPY has dropped to a seven-month low near 154.50, while the US Dollar Index (DXY) hovers near two-week lows around 98.91, down 0.25% for the day.
On the economic data front, the Eurozone economy expanded by 0.6% quarter-on-quarter (QoQ) in the second quarter, surpassing both the previous estimate and the market forecast of 0.4%. Additionally, annual growth was revised upward to 1.2% from the initial 1.0%.
However, the pair’s upward momentum may be limited ahead of the European Central Bank’s (ECB) monetary policy announcement scheduled for Thursday. The ECB is widely anticipated to increase its Deposit Facility Rate by 25 basis points (bps) to 2.50%, marking the second increase this year. This move is driven by persistent inflation concerns stemming from elevated energy prices due to the conflict in the Middle East.
Strategists at Brown Brothers Harriman (BBH) noted that the upcoming ECB meeting will also feature the central bank’s September macroeconomic projections. They do not expect significant revisions to the Eurozone GDP and inflation forecasts, arguing that “improving leading economic indicators and slightly softer core inflation are broadly offset by higher energy prices,” leaving the overall outlook relatively unchanged.
In their view, the “bottom line” is that “the Eurozone macro backdrop argues in favor of bringing the policy rate closer to the upper end of the ECB’s 1.75%-3.00% neutral range.” BBH further added that “the swaps curve more than fully prices in ECB rates at 3.00% in the next twelve months, which is EUR supportive.”
Geopolitical tensions escalated over the weekend after the US military confirmed strikes on three Iranian crude oil tankers on Saturday, retaliating for Iran’s ballistic missile attacks on two US Navy ships. Additionally, The Financial Times reported that Saudi Aramco’s Jazan refinery was hit by a fresh strike on Monday. West Texas Intermediate (WTI) crude oil is trading around $90.50 per barrel, near its highest level since July 24.
Looking ahead across the Atlantic, US inflation data will be closely monitored for insights into the Fed’s upcoming policy decisions, especially following Friday’s strong employment report. The Producer Price Index (PPI) is scheduled for release on Thursday, followed by the Consumer Price Index (CPI) on Friday. According to the CME FedWatch Tool, traders are currently pricing in approximately a 58% chance of a rate hike at the September 15-16 meeting.
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.
