FX Daily: Can the ECB help the euro?

USD: Powell will remain hawkish
The dollar has entered a new phase of consolidation, although very close to the highs of the year. Following Fed Chairman Powell’s hawkish speech in Jackson Hole a few weeks ago, Fed cycle prices have remained remarkably stable. The cycle should peak around 3.90% next spring and soften to 3.60% by the end of the year. We suspect that the 2023 year-end price of a cut could still be assessed, as the Fed continues to stress that policy needs to be conducted in restrictive territory and held there for some time. A fresh dose of Fed hawkishness is expected to come in a Fed Powell speech at the Cato Institute at 3:10 p.m. CET today.

With the Fed/Dollar side of the FX equation fairly stable, the focus is increasingly on the reaction of trading partners. Overnight, Reserve Bank of Australia (RBA) Governor Philip Lowe said it would likely shift to a slower rate of upside – comments that weighed on the Aussie dollar. We comment below on today’s main event, the ECB meeting, but the focus is also on USD/JPY this week. This jumped more than 3% and remains ahead of the sharp dollar and energy crisis.

Japanese policymakers have stepped up their rhetoric in favor of the yen – for example calling the moves one-sided – but equally, the finance minister’s comments that a weak yen has “its merits and demerits” do not provide a consistent message here. . Early in European trading, USD/JPY sold off on news of a meeting between the Bank of Japan, the Ministry of Finance and the Financial Services Agency – potentially to discuss intervention in the Change market. But the base case is probably that we don’t see intervention until closer to 150 in USD/JPY. And the FX options market certainly doesn’t see the imminent risk here. Still, USD/JPY implied volatility looks too cheap in our view.

The ECB meeting will be key for European currencies and the DXY today. We don’t expect a significant reversal anytime soon and believe the corrections will likely hold the 109.00/109.25 area

Chris Turner

EUR: will the ECB comment more directly on the euro?
Please see our full overview of the ECB here. We have also presented scenario analysis in our ECB bed sheet. Our base case is for the ECB to increase only 50 basis points from the consensus of 75 basis points and the 67 basis points valued by the money markets. In theory, this should be Euro negative and we have a base case of EUR/USD falling back to 0.9900.

In our experience, EUR/USD has always been a tough call on the ECB day and the upside risks for the EUR stem from a hawkish message from the ECB. Of particular interest could be the 2024 CPI forecast which, in June, was forecast at 2.1%. Upside or downside revisions could help determine whether the market is correct in pricing an ECB tightening cycle of 225 basis points through 2023. Our macro team certainly thinks the ECB will not hold a such cycle.

It will also be interesting to see how President Christine Lagarde (press conference 2:30 p.m. CET) handles any questions on Euro weakness – where the EUR/USD subpar is contributing to the energy shock. Her hands will be tied as to what she can say – the G7/G20 agree on market-determined exchange rates – but any comments along the lines of the ECB ‘watching FX closely’ could trigger a brief EUR/USD counter-trend rally. That said, EUR/USD is trading here for sound macro reasons and we doubt the intraday rallies will last.

We assume that 1.0100 proves the magnitude of any short EUR/USD compression and would favor a return to 0.9900.

Chris Turner

Pound sterling: the method of financing the budget package will boost the pound sterling
The highlight of today’s sterling session will be the announcement of the UK government’s new energy package and in particular how it is funded. The announcement falls around noon. The greater the public funding, the greater the supply of gilts and the greater the pressure on sovereign risk and the pound. Here our team discusses the challenges facing this topic.

After a brief rally earlier this week, the pound looks soft again. Our base case would assume that GBP/USD struggles to break through 1.16 and EUR/GBP tests the June high at 0.8720. Basically, new PM Liz Truss is undertaking an act of highwire and it will be a real challenge to bail out the UK economy without growing concerns over how the UK finances it.

Chris Turner

EEC: a divergence appears between floating exchange rates in the region
In line with surveys, the National Bank of Poland raised its policy rate by 25 basis points to 6.75%. The MPC statement saw only cosmetic changes. The board hopes that the slowing economy will translate into slower inflation and the rate forecast remained unchanged. Today we will attend Governor Adam Glapinski’s press conference which should show the full picture and hint at what we can expect this year. As markets expect a little more from the central bank after surprisingly high inflation, rates are lower across the curve, driving the interest rate differential to its lowest level since March this year. The Polish zloty strengthened slightly, likely supported by lower gasoline prices. The rate cut over the past two days may be enough to cover the governor’s dovish press conference, but we barely see the result supporting the zloty today. So, as we mentioned yesterday, we see room for an upward move in the 4.74-4.76 EUR/PLN band.

Meanwhile, in Hungary, the forint hit its highest levels since mid-August after rates jumped 15-30 basis points across the curve, but with zero liquidity. So, although the forint has followed the movement in rates, we see no reason for levels below 400 EUR/HUF at the moment. However, August inflation could come into play today. Peter Virovacz, our economist in Budapest, expects a jump of 13.7% to 16.2% year-on-year, beating market expectations. Part of the jump is due to changes in fuel price caps. Thus, an inflation surprise could support rate hikes and support current forint levels. However, to keep levels below 400 in the long term, we would like to see tangible progress in the EU negotiations, which could come in the coming weeks.

Frantisek Taborski
Source: ING