Are markets too dovish on the euro?

Written on 08/01/2023
Team UCapital 24

Yesterday’s set of data releases in the eurozone showed the growth and inflation side moving in diverging directions. The euro area grew slightly more than expected, at 0.6% year-on-year (0.3% quarter-on-quarter) in the second quarter, while inflation slowed in line with consensus from 5.5% to 5.3% in July. Core inflation was, however, unchanged at 5.5%.

The most interesting dynamic in inflation, and one that the ECB will likely follow closely, is related to service price pressure. While goods inflation continues to ease, service price pressure has kept mounting in line with wage growth and stronger demand.

In our view, yesterday’s figures leave the door open for another hike by the ECB before the end of the year, even in September. Markets, however, remain reluctant to endorse this scenario and only price in 17bp of tightening by December, likely having read last week’s ECB messaging as a dovish tilt. It is possible investors will want to hear more hawkishness from ECB members before aligning with the data’s indications and fully price in another hike. However, August is a quiet month for ECB speakers: we’ll hear from the dove Fabio Panetta later this week, and that will hardly help.

EUR/USD should be primarily driven by the dollar leg and US data for the remainder of the week, and there are some downside risks to the 1.0900 handle.