Euro-to-Dollar Rate in Sudden Overnight Surge, Weidmann Makes the Case for Interest Rate Rises at ECB

Above: Jens Weidmann, President of the Deutsche Bundesbank advocates for higher interest rates at the ECB, which is positive for the Euro. © European Central Bank

Charts suggest further upside for EUR/USD while a prominent member of the ECB says the time to raise rates is approaching.

The Euro-to-Dollar exchange rate confounded traders when it surged to a new three-year high during overnight trading at 1.2320 only to fall back by more than 100 points before the start of the London session.

“A wild market overnight! There was a sudden spike in EUR/USD in early Asian trading from 1.2271 to 1.2323 on no news whatsoever, then a plunge down to 1.2242 as I write,” says Marshall Gittler, chief strategist at ACLS Global.

Some analysts say the exchange rate may now take a timeout, given the pace of its recent gains however, it remains within a firmly established uptrend and most analysts agree that it will move higher still during the weeks and months ahead.

“EUR/USD charted an inside day and has shot higher overnight. The new high has not been confirmed by the daily RSI and we would allow for a small pullback currently this is indicated to terminate circa 1.2150- 1.2110. Beyond this it remains on course to challenge the 1.2432 200 month moving average,” writes Karen Jones, a technical analyst at Commerzbank, in her morning briefing.

Above: EUR/USD shown at hourly intervals showing the overnight spike.

The rise was aided by talk from European Central Bank policymaker Jens Weidmann who said in an interview with Germany’s Frankfurter Allgemeine Zeitung late Tuesday that expectations that European interest rates would rise before the middle of 2019 are reasonable. 

Weidmann - head of Germany's Bundesbank - has been a long standing critic of the ECB's quantitative easing program and its low interest rate policy and he will be leading the way in pressing for an interest rate rise as early as possible.

Weidmann’s statement has however since been overshadowed by a slew of comments by fellow ECB rate-setters who have honed in on the Euro's recent rise which they believe will work against their aim of pushing inflation higher to their 2.0% target. (Recall, the ECB targets inflation at 2.0% as it aids economic growth, but it has been stuck below 2.0% for some years now).

ECB governing council member and head of France's central bank Francois Villeroy, who told reporters Tuesday that the Euro’s gains in recent months could inhibit the ECB’s ability to exit its QE program.

“Officials have been playing ‘good cop, bad cop’ for EUR bulls – with Villeroy citing FX moves as a source of uncertainty, while Weidmann noted that expectations for a mid-2019 ECB deposit rate hike are realistic,” says Viraj Patel, a strategist at ING Group. “While the latter holds the key to further EUR upside, Villeroy’s cautious take is probably the ECB consensus and this may limit the EUR’s rally for now.”

Adding to the barage of ECB concern is Ewald Nowotny of Austria's central bank who told a Euromoney CCE Conference in Vienna that "the Euro must be observed" in light of recent gains.

Vitor Constancio, who is Vice-President of the ECB, said he is concerned about sudden movements in the Euro which don't reflect changes in fundamentals. Looking at fundamentals, inflation declined slightly in December.

These comments could certainly be responsible for much of the Euro's slide this morning.

Above: EUR/USD shown at weekly intervals confirms the trend is still ultimately higher.

Eurozone policymakers can only turn of the easy-money taps when inflation shows signs of charting a sustainable course back toward its 2% target.

An eventual interest rate rise, however far off in the future that may be, is the bottom line for Euro-to-Dollar bulls. Interest rates are the dominant driver of exchange rates because they have influence over foreign capital flows and speculative money flows.

Rising rates attract new flows of foreign capital while a mere hint of higher rates being on the horizon is enough to attract speculative money flows, which attempt to get ahead of the currency appreciation that follows an upward move in rates.

“We see the EUR as being highly sensitive to 3 factors now: (1) EZ economic data surprises – namely inflation readings (we get the final release of Dec CPI today); (2) adverse political developments, with the immediate focus on the German coalition deal and a key vote this weekend; (3) ECB policy noise ahead of next week’s meeting,” says Patel.

Currently, markets are eagerly anticipating an end to the ECB’s quantitative easing program later this year, likely in September, which marks the last remaining hurdle to higher interest rates in Europe.

For now, above-target inflation seems some way off while currency strength could kick it further out into the long grass because a stronger currency makes imported goods cheaper to buy - thus reducing inflation. Hence Villeroy’s comments on Tuesday.

December’s Eurozone inflation data were disappointing for markets, given the headline consumer price index remained at 1.4% and the more important core-inflation rate held stubbornly below the 1% threshold.

The preliminary readings will be confirmed at 10:00 am London time on Wednesday. Exactly where Eurozone inflation goes in the months ahead remains to be seen but if there is one thing that is for sure, the data will be important for determining whether or not the current EUR/USD bull run can continue.

Readers can learn more about what analysts and strategists say is in store for the Euro-to-Dollar rate in 2018 here; Compilation of Major Bank Forecasts, Currency Views for 2018.

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