FX.co ★ ECB may resort to more effective measures to cap inflation

The euro remains in demand amid rumors that some hawkish officials of the ECB are considering a more active reduction of the ECB balance by 5 trillion euros. After a major sell-off at the end of last week, bulls have already regained all the losses, pushing the price to monthly highs. However, it will be quite difficult to break above such high levels by the end of the week. We will discuss the technical picture in detail below.

First of all, I would like to draw your attention to the fact that some European officials are willing to consider the possibility of selling securities from the ECB portfolio in addition to the steps taken after the recent interest rate hike. However, there are also those who prefer to maintain a gradual reduction of the ECB bond balance accumulated during the pandemic.

Any action aimed at a more active reduction of the balance will limit all the stimuli, which started last year when inflation surged. The main part of the efforts to return inflation to 2% has so far been associated with an unprecedented increase in interest rates. According to President Christine Lagarde, the cycle of the key rate hike is not finished yet.

By ceasing asset purchases, the ECB began reducing its bond portfolio in March, allowing an average monthly reduction of 15 billion euros instead of reinvesting as before. In the following month, it will completely stop reinvesting, roughly doubling this pace.

However, as the balance still exceeds 7 trillion euros, the impact of the process on the same exchange rate and inflation remains relatively small. The larger reduction occurred because of the repayment of cheap long-term financing that officials provided to banks during the pandemic. This week, more than 500 billion euros are planned to be returned, mainly as part of the repayment of a significant portion of the loans. Experts are also confident that the ECB's next step will be an active sale of securities within the asset purchase program of 3.2 trillion euros accumulated when inflation was too low.

Those who oppose this idea note that aggressive portfolio sales will result in significant losses for some central banks in the eurozone that purchased bonds when yields were low.

Recently, Bundesbank President Joachim Nagel hinted that the balance reduction policy might be reviewed. Last week, he stated that the ECB intended to continue reinvestments until the end of next year. He also added that the discussion on the balance was part of a broader ECB policy aimed at lowering inflation.

As for the technical picture of EUR/USD, to maintain control, buyers should push the price above 1.0980 and consolidate there. This will allow them to move towards 1.1010. From that level, it is possible to climb to 1.1060. However, it will be difficult without new positive data from the eurozone. In case of a decrease in the pair, I expect significant actions from large buyers only around 1.0930. If there is no one there, it would be good to wait for a new low at 1.0890 or open long positions from 1.0840.

As for the technical picture of GBP/USD, demand for the pound remains high even despite a slight correction. It will be possible to count on the pair's growth after gaining control over the level of 1.2760. A breakout of this range will strengthen hopes for a further recovery towards 1.2820, after which we can talk about a surge to 1.2880. In the event of a decline, bears will attempt to take control of 1.2690. If they succeed, a breakout of this range will affect bullish positions and push GBP/USD to a low of 1.2630, allowing the price to slide to 1.2570.