EUR/USD testing 1.13 into ECB policy updateCould probe above 1.14 if inflation view shiftsBut ECB seen sticking to December message

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The Euro to Dollar exchange rate already rallied sharply ahead of Thursday’s European Central Bank monetary policy decision but could extend its rebound with an attempted recovery of the 1.14 handle if the ECB comes across as less confident in its December forecasts for inflation.

Europe’s single currency rose sharply against the Dollar early in the new week as U.S. exchange rates softened broadly but did appear to draw a bid of its own during the Wednesday session after Eurostat figures revealed that Eurozone inflation climbed further in January.

January’s 5.1% inflation rate surprised a market that had been looking for a decline from 5% to 4.4% and is a potential curveball for the European Central Bank given it had been looking for continental price pressures to peak around the turn of the year.

“We expect the ECB to stay on-message with no changes to Dec's big policy package announcement. President Lagarde's press conference may be a bit more interesting, but even here, the content is likely to broadly echo December,” says Mark McCormick, global head of FX strategy at TD Securities.

EUR/USD reference rates at publication:

Spot: 1.1292High street bank rates (indicative band): 1.0897-1.0976Payment specialist rates (indicative band): 1.1190-1.1240Find out more about market-beating rates and service, hereSet up an exchange rate alert, here“Our outcomes skew negative for the EUR, reflecting prospects that it remains a key funding currency for a while longer. EURUSD HFFV [short-term fair value estimate] sits at 1.13, where we like fading rallies,” McCormick and colleagues wrote in a briefing on Wednesday.

ECB forecasts suggested in December that Eurozone inflation rates would peak imminently before declining later in the year, while its projections for 2023 and 2024 had price growth slipping back below the bank’s symmetric two percent target before the end of its forecast horizon.

That’s why President Christine Lagarde said in December’s press conference that “it’s very unlikely that we will raise interest rates in the year 2022. That still stands,” which is a position that has been several times reiterated by other members of the ECB’s Governing Council in the weeks since.

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However, this position has always been subject to the risk of change in response to intervening economic developments and given January’s indication that Eurozone inflation pressures could be more persistent than envisaged, there’s a risk the ECB sounds less confident about its forecasts this week.

This kind of an outcome could potentially see the Euro-Dollar rate rise by a further 0.75% from Wednesday’s levels, according to TD Securities’ research, and that would see the single currency attempting to reclaim the 1.14 handle it ceded to the greenback in November last year.

“Risk sentiment is trying to recover its feet after the recent drawdown and as US long yields have steadied. EURUSD has backed up into the upside pivot range, but may need the ECB to guide for rate hikes to sustain further upside,” says John Hardy, head of FX strategy at Saxo Bank.

Above: EUR/USD shown at daily intervals with major moving-averages and Fibonacci retracements of November decline indicating possible areas of technical resistance to any further recovery.

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The Euro-Dollar rate had slipped to 18-month lows near the 1.11 handle last Friday as the U.S. currency strengthened and stocks as well as other risk assets weakened in the wake of January’s Federal Reserve policy decision.

“We’ve long railed against where markets were pricing the terminal rate and argued that a repricing there should be one of the major reasons for the next leg higher for the USD. But Bullard and George’s comments suggest to us that this reason might need to be shelved in the near-term,” says Bipan Rai, North American head of FX strategy at CIBC Capital Markets.

“As such, we now have the USD consolidating in the near-term. Whether this morphs into outright USD selling pressure will depend largely on how well the ECB can push back against hawkish expectations tomorrow,” Rai and colleagues said in a Wednesday market commentary.

Last week’s statement all but confirmed that U.S. interest rates are likely to rise in March while the subsequent press conference with Chairman Jerome Powell did nothing to discourage the market from betting that the Fed could be likely to lift the Fed Funds rate some four times this year.

However, remarks from some of the most hawkish members on the Federal Open Market Committee suggested this week that such a course of action is far from assured, with Federal Reserve Bank of Kansas City President Esther George even going so far as to say that an impending effort to shrink the Fed’s balance sheet could be likely to reduce the number of interest rate rises that would otherwise be deemed necessary this year.