Euro is Today's Best Performer as German Inflation "Still in Full Swing", Further ECB Rate Hikes Likely

Image © Alfred Yaghobzadeh, European Commission Audiovisual Services.

Euro exchange rates can depend on further interest rate hikes at the European Central Bank (ECB) on news inflation in the Eurozone's largest economy continues to see broad-based inflationary pressures.

The Euro was the best-performing major currency on March 30 after CPI inflation from Germany came in ahead of expectations and analysts say this will keep the ECB on the path to higher interest rates.

"Underlying inflationary pressures remain high," says Carsten Brzeski, Global Head of Macro at ING Bank N.V.

German headline CPI rose 7.4% year-on-year in March said Destatis, ahead of expectations for a reading of 7.1% and down on February's 8.7% print.

The month-on-month increase stood at 0.8%, higher than the 0.7% the market was looking for.

"The fact that the month-on-month change in headline inflation was clearly above historical averages for March, there are no reasons to cheer," says Brzeski.

The Euro was the top-performing major currency on the day Germany released the inflation figures, with the Euro to Dollar exchange rate advancing 0.60% to 1.0907 and the Euro to Pound exchange rate pushing higher by 0.13% to 0.8818.

"The European currency shared by 20 countries is enjoying twin tailwinds related to reduced anxiety over banking instability that’s sapping safety flows into the dollar, and expectations that the ECB has more rate hiking to do over the balance of the year than the Fed," says Joe Manimbo, Senior FX Analyst at Convera.

ING says there are two camps out there offering two different interpretations of the data with differing potential implications for the Euro outlook.

Camp one will view the sharp drop in headline inflation as confirmation the spike of the past year is a long and transitory energy price shock.

This camp might be inclined to view the ECB as having the luxury of affording to slow down the pace it hikes rates.

But, ING is in Camp Two:

"If you believe this argument, today’s drop in headline inflation is the start of a longer disinflationary trend. As much as we sympathised with this view one or two years ago, inflation has, in the meantime, also become a demand-side issue, which has spread across the entire economy," says Brzeski.

Above: EUR outperformance on March 30. (Consider setting a free FX rate alert here to better time your payment requirements.)

ING looks for the ECB to hike by 25 basis points on two further occasions, which would exceed what the market is currently expecting from the Bank of England, U.S. Federal Reserve, Reserve Bank of Australia and a host of other developed market banks.

This distinction could therefore offer the Euro further upside against currencies belonging to central banks at the end of their cycles.

Morgan Stanley says the Bank of England is expected to leave interest rates unchanged in May, which in turn will deny UK bond yields of upside support.

The ECB is meanwhile expected to hike up to three more times, offering EUR/GBP upside support.

Morgan Stanley is a buyer of EUR/GBP, targetting an eventual move to 0.93, giving a potential Pound to Euro (GBP/EUR) downside target at 1.0752. (If you are looking to protect or boost your international payment budget you could consider securing today's rate for use in the future, or set an order for your ideal rate when it is achieved, more information can be found here.)