Why is the euro rising? Markets anticipate that both the Federal Reserve System and the European Central Bank (ECB) will start lowering interest rates in June. The Eurozone's economy is evidently weaker than the American one, and at the March meeting of the European Central Bank, a decline in inflation estimates is expected. All these are bearish factors for EUR/USD; nevertheless, the major currency pair is showing signs of recovering lost positions. What is the reason for this? Most likely, it's a reassessment.
Societe Generale suggests that the markets are overly optimistic about the scale of the ECB's monetary policy easing, anticipating a 90 basis point reduction in the deposit rate in 2024. The company predicts merely two instances of monetary expansion. Commerzbank shares a comparable viewpoint, highlighting that wage growth outpaces price growth at a double rate, posing a potential risk for this trend to endure. Despite wage growth slowing for the first time in Q4 2023, its growth rates are still significantly below the necessary 3%. As per the central bank, this figure aligns with a 2% inflation rate.
Dynamics of average wages in the eurozone
Increased attention to wages is not accidental. Labor-intensive services generate them, and the growth in costs in this sector keeps prices at elevated levels. In February, they slowed from 4% to 3.9%, but the latter figure is still very high for the ECB to declare victory over inflation.
The Bank for International Settlements agrees with this. It recommends that central banks keep borrowing costs low for longer, as a higher share of services in the core inflation will anchor it near the 3% mark. As expected, the last mile in the fight against high prices will be the most challenging.
Dynamics and structure of inflation in different countries of the world
The change in the structure of inflation is also of significant importance. If during the pandemic, energy and other goods had a significant share, currently, the recovery of supply chains and the decline in oil prices have led to an increase in the share of services. It is not surprising that ECB hawks increasingly refer to price stability in this sector of the economy.
Thus, betting on a 90 basis point reduction in the European Central Bank's borrowing costs in 2024 looks overstated. Investors will come to understand this due to inflation anchored in the sphere of services with high prices. I believe that the ECB has already understood this, and at its March meeting, it will speak about the gradualness of easing monetary policy. Expectations of its hawkish rhetoric inspire bulls on EUR/USD to attack.
On the other hand, the Federal Reserve is not without its challenges. Inflation in the United States may not only anchor near 3%, but also escalate due to a strong economy, regardless of the federal funds rate starting to rise again. Such a risk allows us to talk about the limited potential for the euro to rise against the U.S. dollar.
Technically, on the daily chart, EUR/USD continues its consolidation within the range of 1.08–1.0865 as part of the formation of the Splash and Shelf pattern. Only a breakthrough of resistance at 1.0865 will allow the formation of long positions. Conversely, a decline in the pair's quotes below 1.08 is a reason to sell.