EUR/USD Recovers above 1.06 Ahead of ECB Decision

EUR/USD Recovers above 1.06 Ahead of ECB Decision

The EUR/USD plummeted during the previous session after a four-day rally as investors became more risk-averse following Credit Suisse’s worsening financial situation. This is one of the first instances in Europe where any bank has experienced severe liquidity problems due to higher borrowing costs.

The pair reversed losses in today’s session, surging to $1.06335 against the USD, buoyed by Credit Suisse’s reveal that they will be able to borrow up to CHF 50 billion from Switzerland’s central bank. This news offered investors a brief respite in light of the current banking sector unrest.

The EUR/USD currency pair has rebounded from Wednesday’s drop to the lowest monthly levels near 1.0510, supported by weakened risk aversion and a renewed selloff in the US dollar.

This comes as all eyes go to the European Central Bank (ECB) rate decision later on the day for any clues on the policy path. 

A renewed fear of a global banking catastrophe drove investors to seek refuge in the US dollar and Japanese yen. This followed news that contagion from Silicon Valley Bank’s collapse had spread over to the Swiss bank Credit Suisse.

ECB Meeting in Focus

Euro traders will be eagerly awaiting the European Central Bank‘s crucial monetary policy announcement at 1:15 GMT. Investors are split on whether the bank will announce a 50bps or 25bps rate hike, given recent turbulence surrounding Credit Suisse and both Signature Bank and SVB collapse in the United States.

The European Central Bank (ECB) is widely expected to raise rates by 50bps. The financial impacts on Eurozone banks appear to be limited and a contained crisis is now expected as the base case scenario. However, there could still be potential issues arising from Credit Suisse’s current dilemma.

The ECB will also be publishing its updated economic projections, with all focus to be turned to Christine Lagarde’s press conference for more clues on future plans of the European Central Bank, as well insights on how recent Credit Suisse turmoil might affect the banking system in Europe.

Deutsche Bank sees that a 25bps rate hike is likely more probable than the 50 bps previously predicted. However, Reuters sources revealed on Wednesday morning that due to the solidity of markets, persisting inflation, and credibility issues, the ECB is still inclined to raise rates by 50bps- precisely what they had hinted at earlier.

The ECB had previously signaled a 50 basis point increase in interest rates, as inflationary pressures across the Eurozone remain elevated. Nonetheless, due to potential ramifications from such an extensive hike in the banking sector, policymakers may instead look for other alternatives.

The inflation rate in the Euro Area remains substantially high and is more than quadruple of the targeted rate at 2%.

EUR/USD and Widening Policy Divergence

The policy divergence between the ECB and Fed is a major factor to monitor when looking at the EUR/USD pair. If the Fed concludes its rate-hiking cycle while the ECB continues its rate hikes, we can expect a potential surge for the pair–as long as worries brought up by Credit Suisse are contained and limited. 

Additionally, shall the dovish expectations of future Federal Reserve interest rates prompt further USD weakening then the outlook for EUR/USD will be tilted to the upside. 

EUR/USD Daily Chart

EUR/USD Analysis

The debate for whether the central bank will hike interest rates or keep them unchanged is the same for the Fed. With the U.S. banking system under pressure, it’s likely that next week the Federal Reserve will refrain from raising rates too drastically, and will likely deliver only a 25 bps rate hike. Some opinions even refer that the bank may favor keeping rates unchanged for this meeting. 

Amidst the unpredictability of economic concerns related to bank stress, Goldman Sachs has revised its estimation of a U.S. recession within the next 12 months from 25% to 35%.

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