ECB rate hike expectations and softer US Dollar lift Euro

EUR/USD advances as firm remarks from ECB policymakers and Eurozone inflation of 4% strengthen the case for a December rate hike.
Despite strong market expectations of a 25-basis-point rate hike by the US Federal Reserve, the US Dollar weakens.
Further upside in EUR/USD may be constrained by robust US jobs figures and forthcoming inflation releases.

Support for the Euro (EUR) is helping EUR/USD recover from two consecutive days of declines, with the pair trading near 1.1150 in Monday's Asian session. Remarks by several European Central Bank (ECB) policymakers, including the German and Italian central bank heads, have supported the single currency by signalling that an interest rate hike in December may be likely.

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The argument for additional monetary tightening has strengthened after Eurozone inflation reached 4% in October, a three-year high fuelled by rising energy costs. Speaking on Thursday, ECB President Christine Lagarde said the central bank was closely assessing incoming data to judge whether an interest rate increase would be justified next month.

A weaker US Dollar (USD) is also supporting EUR/USD. The Dollar's decline comes despite the CME FedWatch tool showing that the probability of another 25-basis-point hike at the Federal Open Market Committee (FOMC) meeting on December 8-9 has climbed to nearly 80%.

However, stronger US employment figures could support the Greenback and weigh on the pair. October Nonfarm Payrolls (NFP) increased by 165,000, exceeding the consensus forecast of 65,000 and September's reading of 60,000. The Unemployment Rate, meanwhile, edged lower to 4.1%, compared with expectations of 4.2%. Investors will now scrutinise Tuesday's US Consumer Price Index (CPI) release and Friday's Producer Price Index (PPI) report for additional clues to the Federal Reserve's forthcoming policy decisions.

Why is the Dollar failing to benefit as yields and Fed rate hike expectations ease?

The latest shift towards risk aversion has offered little support to the Dollar, according to strategists at ABN Amro, who note that "the USD struggled to benefit as US Treasury yields and Fed hike expectations fell." Their assessment echoes wider market commentary: weaker rate expectations are restricting the Dollar's upside despite the risk-off backdrop.

Common questions about the Euro

Which countries use the Euro, and how widely is it traded?

Used by the 20 European Union countries in the Eurozone, the Euro ranks second only to the US Dollar among the world's most traded currencies. Its share of all foreign exchange transactions stood at 31% in 2022, with average daily turnover exceeding $2.2 trillion. With an estimated 30% share of all transactions, EUR/USD is the world's most actively traded currency pair. It is followed by EUR/JPY (4%), EUR/GBP (3%) and EUR/AUD (2%).

What role does the ECB play, and how does it affect the Euro?

Based in Frankfurt, Germany, the European Central Bank (ECB) serves as the Eurozone's reserve bank, setting interest rates and overseeing monetary policy. Maintaining price stability is the ECB's main mandate, whether through curbing inflation or supporting growth. Interest rate increases and cuts are its principal policy tools. The Euro generally benefits when rates are relatively high, or when higher rates are anticipated; the reverse also holds. Monetary policy is decided by the ECB Governing Council at eight meetings each year. The decision-makers comprise the heads of the Eurozone's national banks and six permanent members, among them ECB President Christine Lagarde.

Why do inflation figures matter for the Euro?

Measured through the Harmonised Index of Consumer Prices (HICP), Eurozone inflation is a key economic indicator for the Euro. An inflation reading above expectations, particularly one exceeding the ECB's 2% target, obliges the central bank to increase interest rates to bring price pressures back under control. When interest rates are relatively high compared with those of its counterparts, the Euro usually benefits because the region becomes a more attractive destination for global investors' funds.

Why can economic releases move the Euro?

By indicating the economy's health, data releases can move the Euro. GDP figures, Manufacturing and Services PMIs, employment data and consumer sentiment surveys can each shape the single currency's direction. Economic strength supports the Euro by drawing in more foreign investment and potentially prompting the ECB to raise interest rates, which would directly strengthen the currency. Weak economic readings, by contrast, are likely to push the Euro lower. Particular weight is attached to data from Germany, France, Italy and Spain, the euro area's four largest economies, as together they represent 75% of the Eurozone economy.

Why is the Trade Balance important for the Euro?

The Trade Balance is another key release for the Euro, showing the difference between a country's export earnings and its import spending over a specified period. Strong foreign demand for a country's exports creates additional demand for its currency as overseas buyers seek to purchase those goods, thereby lifting its value. A positive net Trade Balance therefore strengthens a currency, while a negative balance has the opposite effect.