The ECB to Hike, But Euro Rally May Be Short-Lived as Dollar Strength Persists
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FX Daily: ECB to hike, but don’t get too excited for the euro
It’s a close call, but we expect a 25bp hike by the ECB today. Markets are pricing in a 65% implied probability of a hike, so EUR/USD should rise after the announcement if we are right. However, a full 25bp are factored in by year-end, and it will be hard for Lagarde to convince markets the ECB can push rates even higher. Any EUR rally may be short-lived.
USD: Muted reaction to CPI, but still good news for the dollar
US inflation came in slightly hotter than expected in the August report released yesterday. As noted by our US economist here, the core print was 0.278%: not a terrible miss to the 0.2% consensus, but probably enough to convince the majority of FOMC members to keep one rate hike in their end-2023 dot plot projections. The headline surprise was, instead, primarily driven by the 10% jump in gasoline prices.
The market reaction was, however, quite muted. We could speculate on some extremely forward-looking interpretation of the data, but we think it was just a case of rates and FX having priced in an above-consensus CPI ahead of the release. Still, the broader dollar story is firmer now heading into next week’s Federal Reserve meeting. A hike is unlikely, and dot plots will move the market. If the blip in the disinflation process that emerged in these August figures prevents a big dovish revision of the 2023 dots, then the evidence of US economic resilience since the last projections (June) means the 2024 dots could be revised higher. It all argues against any near-term turn lower in the greenback; that is, unless US activity data starts to disappoint.
Today, markets will closely watch the European Central Bank, but the US calendar is also quite busy. Along with the jobless claims – which dropped much more than expected last week – retail sales, PPI and Empire Manufacturing figures for August will be released. We see DXY contracting on the back of the ECB hike, but as we discuss below, we don’t expect the EUR/USD rally to be long-lived: the dollar index could be trading back around 104.50/105.00 before the Fed meeting.
