EUR/USD: ECB Hikes and euro falls as stagflation risks grow; Dollar strength extends after US retail sales data

• Euro falls to the lowest levels since May after ECB hikes rates and delivers an abysmal growth forecasts, while upgrading 2023 and 2024 inflation outlooks
• Post ECB decision – October 26th ECB rate hike odds hover around 35.4%
• US retail sales remained strong on back-to-school spending and despite the extra energy costs at the pump

The euro initially spiked after the ECB raised rates, but quickly tumbled after traders digested the ECB forecasts that suggest stagflation might be here.  Shortly after, the US posted robust retail sales and jobless claims data, which basically drove home the message that the US economy will easily outperform the eurozone economy throughout the rest of the year.  Investors were thinking that the US might be poised to deliver more rate cuts than the eurozone, but that seems like that won’t be happening anytime soon.

EUR/USD – 30 minute chart

ECB

The summer break is over for the ECB and they have a tough job ahead.  Inflation remains too high and that is forcing the ECB to signal that they ” will ensure that the key ECB interest rates will be set at sufficiently restrictive levels for as long as necessary.” The market was split on whether they would raise rates, but when processed the forecasts, they realized stagflation risks are here.

ECB Forecasts: 

2023 GDP forecast cut from 0.9% to 0.7%

2024 GDP forecast cut from 1.5% to 1.0%

2023 GDP forecast cut from 1.6% to  1.5%

2023 Inflation forecast raised from 5.4% to 5.6% (core steady at 5.1%)

2024 Inflation forecast raised from 3.0% to 3.2%(a tick lower to 2.9%

2025 Inflation forecast lowered from 2.2% to 2.1%(core a tick lower to 2.2%)

ECB’S Lagarde Press Conference

When asked if she was done with rate hikes, Lagarde noted that some members preferred to pause, but that still a solid majority of members agreed with the decision.  One of the key takeaways from Lagarde is that they won’t be cutting rates anytime soon as inflation is still far from target.  Lagarde repeated this quote a few times, “based on current assessment…. the key ECB interest rates have reached levels that, maintained for a sufficiently long duration, will make a substantial contribution to the timely return of inflation to the target.”

EUR/USD – Daily Chart

The euro might not be ready to punch a one-way ticket to the 1.05 level, but it sure seems like it is heading there.  Price action on the EUR/USD daily highlights the bearish trend has firmly been in place since mid-July.  As the risks for growth continue to deteriorate even further, the euro could see short-term weakness before a bottom is put in place.  Major long-term support could be provided by the 1.04 level, which is the 50% Fibonacci retracement of the September low to July high move.

On the other side of the Atlantic, another round of US data supported USD strength after it reminded investors how strong the US economy remains; retail sales ex-auto had a fifth straight increase, producer prices came in hotter-than-expected, and jobless claims remained low.

dollar
inflation
stagflation
interest rates