Has the euro rally got legs?

The euro made a strong start to the week on Monday, pushing above the 1.06 handle on the back of hawkish commentary from President Lagarde and other ECB policymakers. There’s little doubt now that the ECB is looking to hike rates as soon as July.

Early on Tuesday, EURUSD broke into the 1.07s, and traders are starting to ask if the rally has legs…

What’s driving it?

First up, Lagarde’s recent commentary was cemented in an ECB blog post over the weekend. The post covers the many challenges policymakers face in the current environment, but this part got the market’s attention (emphasis added):

With the inflation outlook having shifted notably upwards compared with the pre-pandemic period, it is appropriate for nominal variables to adjust – and that includes interest rates. This would not constitute a tightening of monetary policy; rather, leaving policy rates unchanged in this environment would constitute an easing of policy, which is not currently warranted.

Against the backdrop of the evidence I presented above, I expect net purchases under the APP to end very early in the third quarter. This would allow us a rate lift-off at our meeting in July, in line with our forward guidance. Based on the current outlook, we are likely to be in a position to exit negative interest rates by the end of the third quarter.

Interest rate markets had been pricing in an ECB response for some time, so this should come as no shock. However, it comes hot on the heels of commentary from ECB officials noting the downside of a weak euro in their inflation battle.

French central bank governor, François Villeroy de Galhau noted that a weaker euro would undermine the ECB’s goal of price stability, while. ECB executive board member, Isabel Schnabel, said that the ECB was closely monitoring the impact of the weaker euro on inflation.

Wage Growth To Fuel Economic Growth

Economists and commentators have noted the relatively low wage growth in the eurozone compared to the US or UK, but there are signs this might be changing. This chart is from Tuesday’s composite PMI data:

Chris Williamson, Chief Business Economist at S&P Global Markit Intelligence notes that:

Eurozone employment growth at highest since July 2021, with France reporting the largest payroll increase since March 2001 as the services economy booms amid pent up demand and looser covid-19 restrictions.

Germany’s Bundesbank chief Joachim Nagel thinks there will be more to come later in the year:

"I believe that in the second half, we will see high numbers coming from the wage negotiations,"

European tourism is set for a bumper summer too. According to Siteminder, some of the world’s biggest travel destinations are bracing for a summer of high hotel occupancy, as booking volumes edge towards 100% of 2019 levels globally.

Momentum in France and Spain, historically the world’s two most visited nations, is sitting at 109% and 117% of 2019 levels respectively, with over 50% of bookings made in the last two weeks being for June or July stays.

For now, the ECB is signalling two hikes for Q3, and a strong summer of tourism and services spending looks likely.

However, none of the underlying economic issues have been definitively resolved. Debt loads in the periphery nations are still high and energy prices are expected to remain elevated, so this euro relief may prove to be temporary.

Not investment advice. Past performance does not guarantee or predict future performance.