During the holiday week, the euro outperformed the US dollar. This was in part due to the weakening of the US dollar, which fell 1% on two consecutive days. The euro was also driven by a drop in European natural gas prices, which gave the euro a boost. The euro may be facing a bigger challenge in the coming months.
The euro has been under pressure lately due to the deteriorating eurozone outlook. The war in Eastern Europe and Russia’s invasion of Ukraine are dampening the euro’s economic prospects. Meanwhile, higher European gas prices are harming the relative competitiveness of European households and businesses.
On 8 September, the European Central Bank raised its key interest rates by 75 basis points to 1.25%, 1.50% and 0.75%. This decision came against the backdrop of a potential euro area recession in the near future. The euro has been caught in a tight spot between inflation running hot and recession. This could leave the ECB with a tough choice. It may choose to stick to a tightening stance or opt for a less aggressive pace. Inflation is a key driver for the ECB, and may help to mitigate the impact of its policy decision.
After the ECB hiked its rate, EUR/USD rebounded to $1.0100. The euro then fell below parity on 27 September. However, the pair has since recovered. The euro reached the highest level since mid-September at around 1.0100 during Asian trading hours. However, the pair has consolidated since Wednesday, and may continue to do so. It appears that the pair has reached the upper boundary of its range, but a break below parity may push it towards 0.9950, which is significant intra-day resistance.
EUR/USD may also try to test the September high. The EUR/USD is currently hovering around $1.00, but it may be able to extend its gains if the ECB surprises later. If the ECB re-affirms its commitment to an aggressive tightening stance, the euro could build on its recent momentum.
Another important factor for the euro is the divergence between European and US natural gas prices. Russia’s decision to shut down its main gas pipeline to the EU has added to the continent’s energy crisis, and will likely lead to a further cut in supply. The shutdown of the pipeline will have a number of effects on Europe’s economy. It will also set the stage for a cold winter.
Inflation in the Euro Area is at a record high. Last month, the eurozone CPI increased by a record 9.9%. The inflation rate is expected to stay around that level. In addition, the core CPI is expected to accelerate slightly, which is another factor in the ECB’s favour. However, it is the headline CPI that may be more influential.
In addition to the aforementioned factors, the US economy may also affect the direction of the euro. The US economy has been shrinking by 0.6% in the second quarter, while the economy of China has been slowing down. If the US data does not support the Fed’s rate plans, the euro could be hurt. The US Federal Reserve’s preferred inflation gauge is the PCE core. It is expected to slow down in October. This could keep the dollar from rallying.