Euro analysis interest rate outlook

In terms of EUR/USD we have seen the euro fall in response to Russia's invasion of Ukraine and the trend is down. Below a summary of the fundamentals, sentiment and key technical levels of support and resistance.

Inflation and Interest Rates

Flash HICP inflation increased to 5.8% y/y in Feb, up from 5.1% y/y in Jan. The increase was largely due to an increase in commodity prices which are likely to push inflation even higher in coming months. Higher inflation though does not mean higher interest rates.

Higher commodity prices from here are likely to increase the risk of a recession. The ECB is unlikely to increase interest rates into a supply shock which is due to the Russia-Ukraine conflict. Europe is heavily reliant on Russian energy with Russia presently supplying 25% of Europe's oil and gas. Energy prices are high and expected to remain elevated in the coming months. In response to this, the ECB will be patient not just in terms of raising interest rates but also in terms of reducing stimulus.

In terms of the market, it was discounting four rate hikes by the ECB this year a month a ago but still sees more than two hikes this year which can be seen on the chart below:

This could prove to be optimistic judging by recent comments from ECB members.

Interest Rate Differentials and Economic Growth Favour the USD

Even if the ECB does hike twice, the Fed will hike more times with the market discounting 5 rate hikes. Economic growth is stronger in the US, inflation is higher and interest rate differentials are in favour of the USD both now and going forward.

Technical Analysis On the daily chart we have resistance at 1.1200 and 1.1300. On the monthly chart we have major support at 1.0500 and key resistance is at 1.1300.

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