Fighting Inflation at All Costs

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The macro point

The challenge is the same for all central banks across the globe: combating inflation. For some, the task is much more complicated than for others. In Turkey, the consumer price index rose to nearly 70% annually in April, and the producer price index (which indicates upcoming inflation) is in triple digits. In the United States, inflation is lower at 8.5% in April, but it is equally uncomfortable for consumers and businesses. Unsurprisingly, the American Federal Reserve (Fed) was forced to act last week. It decided to raise its key interest rate by 50 basis points. It’s the first time in twenty-two years. It is now between 0.75% and 1.0%. Further rate hikes are 'on the table' in the coming months, said Jerome Powell, the institution's president. He indicated that two rate hikes similar in magnitude to May's are possible in June and July (on June 15 and July 27, respectively). Measures to withdraw liquidity (reduction of the central bank's balance sheet) were also announced. The process will begin next month, at a rate of $95 billion per month once the cruising pace is reached. The withdrawal of liquidity should help, among other things, to reduce real estate prices, which have risen sharply since Covid. However, such a process is not without risks. It can cause significant turmoil in financial markets, which could force the Fed to stop balance sheet reduction sooner than expected. Powell also acknowledged in his press conference that the measures unveiled will have no effect on the soaring commodity prices. Reducing inflation will be a complicated exercise. The positive point is that the American economy is certainly capable of enduring several consecutive rate hikes (which lead, for example, to less easy access to liquidity). The US GDP contracted in the first quarter, but it was mainly related to external factors (international trade). Consumption, which remains the main driver of economic growth, is holding up, particularly thanks to a very dynamic labor market.

On this side of the Atlantic, attention has been focused mainly on the Bank of England (BoE) meeting. It has sent a chill through the forex market. The main key rate was raised, as expected, to 1% (an increase of 25 basis points). It’s a high point since 2009. But the BoE painted a grim picture of the British economy for the coming months: inflation is expected to reach double digits this year (!) and the risk of recession has increased sharply in a matter of months. Former members of the BoE’s Monetary Policy Committee (the body responsible for steering key rates) even believe the UK is already in recession. From our point of view, the developed economy most weakened in this post-Covid period is the UK, just before the German economy (which is also showing serious signs of weakness).

Finally, the debate is intensifying in the eurozone regarding the opportunity for a first key rate hike (which could be of low magnitude, perhaps only about 15 basis points). Several members of the Governing Council have clearly indicated that a rate hike could be appropriate in the coming months (either in July or September). This could provide some support to the single currency against the US dollar (and thus reduce imported inflation). But it may take a few more weeks to have more visibility on the future of monetary policy in the eurozone. Only one member of the Governing Council, Fabio Panetta, has publicly stated that a rate hike would mainly have negative consequences, exacerbating the already ongoing economic slowdown (a statement made last Thursday).
In the forex market, the euro has rebounded against its main counterparts (weekly change): +0.30% against the US dollar, +0.63% against the Canadian dollar, +1.73% against the Swiss franc, and +2.33% against the pound sterling. This is mostly a technical rebound and not a lasting comeback of the single currency. The euro remains in a long-term downtrend against the greenback as long as the resistance at 1.0730 is not broken (for now, a distant target). Our target is at 1.0408 (serving as support). It could be reached in the coming weeks. Profit-taking is also expected on pairs where the single currency has significantly appreciated in recent sessions (against the pound sterling, in particular).

The supports and resistances displayed below indicate the respective low and high points within which the prices should evolve during the week.

	SUPPORTS	WEEKLY	RESISTANCES	WEEKLY
	S2	S1	R1	R2
EUR/USD	1.0248	1.0408	1.0652	1.0730
EUR/GBP	0.8058	0.8283	0.8649	0.8732
EUR/CHF	1.0140	1.0278	1.0588	1.0812
EUR/CAD	1.3382	1.3497	1.3958	1.4120
EUR/JPY	134.28	135.89	139.17	140.81

Inflation will once again be the major point of focus in the upcoming sessions. The publication of the consumer price index (on May 11) and the producer price index (on May 12) in the United States will be the highlight of the week. Barring any last-minute surprises, the increase is expected to continue in both cases. This will simply reinforce expectations of monetary tightening by the Fed. In theory, this is positive for the US dollar (against other currencies).

Below are the publications and events that should have a major impact on the evolution of currency rates.

DAY	TIME	INDICATOR	WHAT TO EXPECT?
10/05	11:00	ZEW Economic Sentiment Index (May)	Drop to -48 against -41 in April.
11/05	14:30	Consumer Price Index (April)	Analysts expect further progress to 8.7% year-on-year (against 8.5% in March).
12/05	14:30	Producer Price Index (April)	Slowdown in monthly increase: 0.5% against 1.4% in March.
13/05	16:00	University of Michigan Confidence Index (May)	Drop to 63.8 against 65.2 in April (the decline is linked to the rise in inflation).