Euro drifting, markets eye PMIs

The euro showed some volatility at the start of last week but since then it has been in calm waters and has stayed close to the 1.0.7 line.We’ll get a look at eurozone and German PMIs on Tuesday.

ECB signals another 50 bp hike

The ECB has been criticized for sending mixed messages to the markets, but Christine Lagarde was crystal clear last week when she told EU lawmakers that “in view of the underlying inflation pressures we intend to raise interest rates by another 50 basis points at our next meeting in March”. Lagarde said the ECB would then evaluate future moves, but with inflation still high, the risks for further rate hikes are skewed to the upside.

The ECB’s primary focus is to tame inflation. Headline inflation fell to 8.5% in January, down from 9.2% in December, but is still unacceptably high. Core CPI has been stickier than expected and wage increases are stemming the drop in inflation. ECB member Isabel Shnabel said last that investors risk underestimating inflation, a warning that the Fed has also made to the markets that have consistently been more dovish about rate policy than the Fed. Schnabel noted that the disinflation process has not started in the eurozone, another signal that the central bank will remain in a hawkish mode for the near future.

Fed members continue to pound out the message that inflation remains too high and more rate hikes are needed. Investors are clearly concerned that the Fed will make good on these statements, which has sent risk sentiment lower and the US dollar higher. The markets had high hopes that the March rate increase would be a ‘one and done’, but it looks like the Fed will continue raising rates into the second quarter. According to CME’s FedWatch, the markets have priced in an 83% probability of a 25-bp hike and a 17% chance of a 50-bp increase.

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EUR/USD Technical

• EUR/USD is testing resistance at 1.0704. Above, there is resistance at 1.0795
• 1.0604 and 1.0513 are the next support lines

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