The ECB´s dovish hike: EUR falls as ECB signals end to rate rises and projects lower eurozone growth

Following on from the mixed US inflation figures yesterday, all eyes were on the ECB – as the decision on whether to raise interest rates or hold steady rested on a knife-edge. In the end, the ECB decided on a 25bps rise to 4%, its highest-ever level, but made it clear in the accompanying statement that this was the end of the road for rate hikes:

“Based on its current assessment, the Governing Council considers that the key ECB interest rates have reached levels that, maintained for a sufficiently long duration, will make a substantial contribution to the timely return of inflation to the target.” 

The statement was also hard reading for eurozone residents and investors, with the ECB now predicting a slower fall in inflation and lower growth for the next 24 months.

“ECB staff macroeconomic projections for the euro area see average inflation at 5.6% in 2023, 3.2% in 2024 and 2.1% in 2025. This is an upward revision for 2023 and 2024 and a downward revision for 2025. The upward revision for 2023 and 2024 mainly reflects a higher path for energy prices… With the increasing impact of this tightening on domestic demand and the weakening international trade environment, ECB staff have lowered their economic growth projections significantly. They now expect the euro area economy to expand by 0.7% in 2023, 1.0% in 2024 and 1.5% in 2025.”

The EUR/USD initially spiked at the news of a rate hike, but as traders digested the statement, the EUR tumbled against the USD, dropping from 1.073 to 1.066 before recovering. The same effect was seen in all EUR crosses with other major currency pairs.

In her statement after the decision, Christine Lagarde, President of the ECB, made it clear that the decision to raise rates was not a unanimous one, saying that some members of the committee “would have preferred a pause”. Lagarde also attempted to leave the door open for future rate hikes, but most analysts remain convinced that the ECB’s hawkish monetary policy is at an end.

The EUR/USD slump was compounded by stronger than expected retail sales and PPI data coming from the US, showing inflation still climbing but consumers still spending – signalling strength in the US economy and more reason for the US Federal Reserve to raise interest rates again before the end of the year.

The big story here, though, is economic weakness in the eurozone and the consequences for the EUR. With interest rate rises off the table for the foreseeable future and a forecast of continued high inflation and tepid growth, the longer-term outlook for the EUR looks bleak. While there will be turbulence over the coming months, we can expect to see continued downward pressure on the EUR from all major currencies until the end of year.

Technical Analysis

From July 2023, after jumping to its highest level (1.1264) since February 2022, the EUR/USD has been on a steady trajectory downhill. It passed through the Fibonacci 23.6% level of 1.0857 before retracing briefly and then swiftly falling to 1.0684 last week. There were a number of factors that precipitated this bearish move, including the ISM non-manufacturing PMI, which showed that the U.S. services sector grew strongly in August, rising to 54.5 versus the expected 52.5, reaching its highest mark since February. This strong US economic data indicates that the US economy remains remarkably resilient.

EUR/USD Daily Chart

Of course, in the immediate aftermath of the ECB rate announcement, hinting that rates have peaked, the pair fell more than 60 pips in 20 minutes, down from 1.0730 to 1.0668. Although there may be some correction following the announcement, with the RSI bouncing around in oversold territory and the MACD in the negative, all three moving averages, the 200 SMA (pink), the 50 EMA (purple), and the 26 EMA (yellow) show strong downward momentum is set to continue. Traders will be eyeing the Fibonacci 38.2% support level of 1.0607 (seen in the chart above).

EUR/USD 5-minute Chart