EUR/USD: Correction unfolds as ECB nears decision – MUFG

MUFG’s Lee Hardman highlights that EUR/USD has slipped back below 1.1700 as the Euro corrects lower into the ECB meeting. Rising Oil prices are increasing stagflation risks for Europe, yet narrowing yield spreads versus the US and expectations for multiple ECB rate hikes have helped the Euro hold up better than historical oil-price sensitivities would suggest.

Euro pressured by energy and ECB

"The euro has dropped backed below the 1.1700-level overnight hitting a low of 1.1655. The euro is correcting lower ahead of today’s ECB policy meeting after recently rising to a high of 1.1849 on 17th April."

"Still, the euro is holding up better than we had initially anticipated in response to the energy price shock. Based on past price action, we would have expected the euro to weaken by around -0.7% for every 10% increase in the price of oil."

"So far the price of Brent has increased by just over 70% since the conflict started but EUR/USD has only declined by just over 1% (rather than by around -5.0%). It highlights the disappointing performance of the US dollar but still makes us wary that the euro could weaken much further if the energy price shock continues to intensify."

"One reason why the euro has held up better than expected against the US dollar has been the narrowing of yield spreads the euro-zone and US. Market participants expect the ECB to be more active in tightening policy than the Fed in response to the energy price shock."

"The ECB has clearly laid out that in the adverse scenario, measured policy tightening is likely to be required.. It supports our forecast for 50bps of rate hikes. We expect today’s policy update to leave policy guidance unchanged and tee up a hike at the next policy meeting if the situation in the Middle East does not improve quickly"

(This article was created with the help of an Artificial Intelligence tool and reviewed by an editor.)