Euro Forecast: EUR/USD Rebound Vulnerable to Rising US Inflation

Euro Talking Points

EUR/USD attempts to retrace the decline from the start of the year following the weaker-than-expected US Non-Farm Payrolls (NFP) report, and data prints coming out of America may continue to influence the exchange rate amid the diverging paths between the European Central Bank (ECB) and Federal Reserve.

Fundamental Forecast for Euro: Neutral

A near-term correction appears to be taking shape in EUR/USD as the 199K rise in US employment casts doubts for an imminent Fed rate hike, and the renewed restrictions driven by the Omicron variant may force the Federal Open Market Committee (FOMC) to delay normalizing monetary policy as the “uncertainty about the economic outlook remained high.”

The ECB faces a similar dilemma amid the growing number of COVID-19 cases in Europe, but signs of sticky inflation may put push the Governing Council to develop an exit strategy as the President Christine Lagarde and Co. plan to“discontinue net asset purchases under the PEPP (Pandemic Emergency Purchase Programme) at the end of March 2022.”

It remains to be seen if the ECB will adjust the forward guidance at its next meeting on February 3 as the core Consumer Price Index (CPI) holds steady at 2.6% per annum for the second month, which is the highest reading since the data series began in 1997, and speculation for a change in regime may keep EUR/USD within the November range as the “Governing Council stands ready to adjust all of its instruments, as appropriate and in either direction, to ensure that inflation stabilises at its 2% target over the medium term.”

Nevertheless, the update to the US CPI may sway EUR/USD over the coming days as the headline reading is expected to increase to 7.1% from 6.8% in December to mark the highest reading since 1982, and evidence of stronger price growth may trigger a bullish reaction in the Dollar as it puts pressure on the FOMC to implement a rate hike sooner rather than later.

With that said, EUR/USD may continue to track the November range over the coming days as it attempts to retrace the decline from the start of the year, but fresh data prints coming out of the US may sway the exchange rate as the Fed prepares to implement higher interest rates while the ECB remains in no rush to normalize monetary policy.

— Written by David Song, Currency Strategist

Follow me on Twitter at @DavidJSong