Euro Rallies against Dollar and Pound on ECB Inflation Rumour

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The struggling Euro recovered ground to record a positive daily close against both the Dollar and British Pound following a report that suggested the European Central Bank (ECB) would release a higher-than-expected inflation report on Thursday that might justify another interest rate hike.

A Reuters report said the ECB’s quarterly projections will show inflation remaining above 3% in 2024.

The market read this as a 'hawkish' development in that it implied the ECB might be in a position to raise interest rates by a further 25 basis points while maintaining a commitment to further interest rates.

This as market pricing showed investors were positioned for no change in rates on Thursday.

"An overnight news headline that the ECB is expecting euro area inflation to stay above 3% next year helped EUR/USD turnaround abruptly from an intraday selloff," says Alvin T. Tan, Asia FX Strategist at RBC Capital Markets. 

The Euro to Dollar exchange rate had been as low as 1.0705 on Tuesday before rising to close the day higher at 1.0767. The Euro to Pound exchange rate had been as low as 0.8569 but rallied 0.40% off the lows to close at 0.8605.

Joseph Capurso, strategist at Commonwealth Bank says the Euro unwound its earlier losses following the Reuters report, but he also notes that Eurozone economic growth will also be downgraded for 2023 and 2024.

"We expect the ECB to increase its policy rates by 25bp tomorrow. The OIS market is pricing around a half chance of a 25bp hike. Given market pricing, EUR will react tomorrow in response to the ECB’s decision," he says.

Tan at RBC Capital says the news sets up for a more interesting ECB meeting tomorrow with the market now pricing in more-than-even chance of a rate hike.

"The weaker EUR and rise in oil may trigger ECB to hike 25bp, which would give EUR a boost (10bp priced), if ECB sticks to a tightening bias," says Anders Eklöf, an analyst at Swedbank.

Dominic Bunning, Head of European FX Research at HSBC, says the ECB meeting on Thursday has the potential to create some volatility for the Euro.

"For the EUR, we are increasingly sceptical that a hawkish rate decision this week will provide much upside relief. Even if the full surprise of a 25bp hike passed into 2y swap rates, a regression analysis of the last 3m would suggest EUR-USD would bounce by 0.7%. But any bounce would likely be short-lived," he says.