US Dollar Price Movements

The US Dollar retreated after hitting a 19-year high last week. Buyers were unable to stop the declines after the major broke into parity last week and last Thursday morning saw a disturbing break below the major figure in EUR/USD.

This week European inflation was above 8% again (8.6% to be exact) and core inflation was 3.7%, the same as last month. As of now, the ECB is still sitting on negative rates, which makes little sense given the levels of inflation seen in the Eurozone. And this problem has the potential to create even more problems, as a falling Euro will push inflation even higher as products imported into the Eurozone are relatively more expensive. At some point, the ECB needs to accelerate tightening or the US needs to cool down, because as long as this divergence continues and as long as the US dollar pulls capital flows out of Europe to capture these new, higher rates, the European economy will remain in a fragile position and the repercussions of a falling currency will probably show up in the coming months. It may even offset the ECB's tightening efforts, especially if we see this 8% inflation being addressed with 25 basis point rate hikes. Which brings us to the final driver that helped the USD pull back while the EUR/USD pair rose slightly, creating expectations for a 50 basis point hike in tomorrow's rate decision. Of course, it has become fashionable for Central Bankers to surprise on the upside with rate hikes; we saw the Bank of Canada go to 100 bp earlier this month after the Fed's first 75 bp move in over 25 years. The question is what will follow: Will a 50 bp hike signal an ECB more ready to tackle inflation? Or will the bank remain loose and passive and portray tomorrow's hike as a 'one-off' or the start of a slow and methodical hiking cycle? If the ECB can convince that it is ready to tackle inflation head-on by continuing to hike rates after tomorrow, the upward movement in the EUR/USD pair could continue for a while, but this may have to wait for the FOMC rate decision a week later.