EUR/USD: Recent shifts in ECB and Fed rhetoric are bearish for the euro

The recent dovish shift in European Central Bank rhetoric alongside a hawkish shift in Federal Reserve rhetoric are expected to drag the EUR/USD pair down, economists at MUFG Bank report.

See: EUR/USD to drop substantially towards 1.15 by year-end – ABN Amro

Sharp increase in use of Fed’s reverse repo facility

“ECB Executive Board member Fabio Panetta reinforced the dovish shift in rhetoric yesterday when he stated that ‘only a sustained increase in inflationary pressures, reflected in an upward trend in underlying inflation and bringing inflation and inflation expectations in line with our aim, could justify a reduction in our purchases… But this was is not what we projected in March. And, since then, I have not seen changes in financing conditions or the economic outlook that would shift the inflation path upwards’. He also expressed concern over the ‘persistent, non-negligible appreciation’ of the euro which ‘if sustained, would weaken inflationary pressures’.”

“We no longer expect the ECB to explicitly commit to a slower pace of QE purchases at the June meeting despite the improving growth outlook and still loose financial conditions in the euro-zone.”

“Recent comments from Fed officials have signalled that they are moving closer to talking about tapering QE potentially as soon as at their upcoming policy meetings. Market participants are also beginning to focus their attention more on the sharp increase in the use of the Fed’s reverse repo facility which increased to $450.3 billion yesterday from just over $100 billion a month ago. It potentially provides another signal that monetary policy settings are too loose and it is time for the Fed to consider scaling back the pace of QE purchases.”

“The recent dovish shift in ECB policy rhetoric and contrasting hawkish shift in Fed rhetoric is a bearish development for the euro. So far it is helping dampen EUR/USD’s upward momentum at just above the 1.2200-level, but remains to be seen whether it will be sufficient to trigger a correction lower in the coming months.”

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