Asymmetry of stagflation risks in EU and US remains key bearish factor for EURUSD

The ECB held a monetary policy meeting on Thursday and sort of announced a reduction in stimulus. However, given recent geopolitical events, markets were clearly hoping for more. EURUSD rallied towards 1.11 in the run up to the meeting on the back of expectations that buying frenzy in commodity markets and inflation pressures related to it will force the ECB to communicate a possibility of a rate hike this year, however those expectations have not been met. As a result, EURUSD erased gains dropping back to 1.10 at the close:Key takeaways from the meeting: The main Pandemic Asset Purchase Program (PEPP) will end in March. Instead, the ECB will ramp up purchases under the standard APP program from €20bn per month to €40bn starting in April. However, in May, the purchase of assets will gradually slow down – in each next month, the volume of asset purchases will be 10 billion euros less per month than in the previous one. The ECB plans to complete QE in the third quarter; The ECB plans to raise the rate “in some time” after the end of QE. At the last meeting, the wording was a bit more hawkish – to raise the rate “shortly after” QE ends; The issue of extending the program of soft loans to EU banks, which are actively engaged in consumer lending, TLTRO, remains open.Comparing with the ECB policy stance in December, one can note noticeable hawkish shifts – for example, transition from PEPP to APP has been brought forward by four months. However, comparing with the February meeting, one can note the desire to expand the room for maneuver. It is clear that the events in Ukraine and the associated sanctions war have increased the risk of stagflation for the EU, which the ECB cannot ignore. Extremely high prices for energy and some commodities, supply disruptions, slowing trade growth, and even contraction in some items create high uncertainty for companies and consumers and change the economic outlook for the bloc rather quickly.Given the rather strong data on the US labor market for February and the acceleration of inflation (from 7.5% to 7.9% in February), the likelihood of a hawkish reaction from the Fed next week, which may exceed expectations, is growing. Accordingly, the market will most likely price in further divergence of the policies of the Fed and the ECB, which is a bearish factor for EURUSD. Of course, the geopolitical premium has risen in the dollar over the last couple of weeks, which could quickly deflate if there are more signs of a de-escalation of the conflict in Ukraine. However, it is unlikely that progress will be made over the weekend or early next week, given that the invasion is still in full swing. It follows from this that the bet on a new wave of EURUSD weakening after the Fed meeting next week looks quite justified.

Source: Tickmill