Inflation is the Theme of the Year

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The macro point

The European Central Bank (ECB) meeting caused a resurgence of volatility on euro pairs during last Thursday’s session (a fluctuation range of 180 pips for the EUR/USD, 120 pips for the EUR/GBP, and 160 pips for the EUR/CAD, for example). Subsequently, the volatility slightly subsided. The ECB did not change its monetary policy. However, it acknowledged that inflation is more persistent than expected (in the eurozone, it reached 5.1% year-on-year in January), which will lead to an upward revision of its inflation projections next March. Additionally, the ECB did not rule out an interest rate increase as early as 2022. Remember, just a few weeks ago, all members of the Governing Council, including the French Christine Lagarde, ruled out such a possibility. The money market now anticipates a first rate hike as early as December 2022. It's a distant horizon. However, this was enough to support the short-term exchange rate of the euro against its major counterparts. It is evident that the ECB faces a major challenge. It wants to further support the economic recovery in the eurozone but faces inflationary pressures that it had evidently underestimated. The central bank meeting scheduled for March 10th will be interesting. It is certain that volatility will be present again.

In the United Kingdom, the Bank of England (BoE) did not catch the market off guard this time. As expected, it announced an increase of its main interest rate by 0.25% to 0.50%. However, traders were surprised to learn that four out of the nine members of the Monetary Policy Committee (responsible for setting rates) voted in favor of a larger increase of 50 basis points. This could indicate that the process of monetary normalization across the Channel will be faster than initially anticipated by traders. Inflation remains a problem. This led the central bank to revise down its growth forecast for this year to 3.75% from 5% anticipated in November 2021. It judged that "the sharp increase in global energy prices and intermediate goods, which the UK is a net importer of, will necessarily weigh on household incomes and spending. This is something that monetary policy could not prevent." The end of the pandemic marked by strong growth benefiting the majority is already a distant memory because of inflation.

In the United States, the labor market is sending conflicting signals. According to the ADP private employment survey, the U.S. economy destroyed 301,000 jobs in January. According to the U.S. Department of Labor’s official report, it created 467,000 jobs. Such a differential is rare. It is explained mainly by calculation differences and difficulties in data collection due to the Omicron variant. In any case, this should not influence the evolution of the U.S. Federal Reserve's monetary policy.

Finally, new rate hikes took place in emerging countries. It was Brazil's turn last week. The Brazilian central bank drastically increased its Selic rate by 150 basis points to 10.75%. At the beginning of 2020, its rate was at 2%. It signaled that the rate hike cycle is far from over. For now, inflation remains high (10.06% last year). However, the monetary tightening is rather beneficial for the local currency, the Brazilian real, whose exchange rate stabilized at the beginning of the year against the euro and the U.S. dollar.
In the foreign exchange market, the euro has regained ground against its main counterparts. The possibility of a rate hike by the ECB in 2022 allowed for an occasionally impressive rebound: +2.8% against the U.S. dollar and +2.5% against the Canadian dollar over the last five sessions. It is difficult to know if this will last. It is likely that there will be profit-taking this week. But the euro could remain generally strong in the coming weeks, at least until the next March meeting of the ECB. We would not be surprised if the EUR/USD pair moves within a rather wide range between 1.11 and 1.15. This does not challenge our long-term bearish view on the pair.

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

	SUPPORTS	WEEKLY	RESISTANCES	WEEKLY
	S2	S1	R1	R2
EUR/USD	1.1030	1.1241	1.1582	1.1693
EUR/GBP	0.8218	0.8336	0.8519	0.8584
EUR/CHF	1.0281	1.0431	1.0652	1.0728
EUR/CAD	1.4070	1.4332	1.4723	1.4833
EUR/JPY	127.19	129.44	132.96	134.24

This week, inflation will still be one of the main focus points in the foreign exchange market. The U.S. Consumer Price Index is expected to rise to 7.2% year-on-year in January, compared to 7.0% in December. Pressure is increasing on the Fed to raise its key rate. This will be done next March. The remaining question is whether the central bank will opt for a small steps policy (several 25 basis points increases this year) or a more aggressive approach (a 50 basis points increase in March to convince traders of its determination to fight high inflation). For now, the money market unanimously expects a first 25 basis points increase.

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

DAY	TIME	INDICATOR	WHAT TO EXPECT?
02/08	14:30	Trade Balance (December)	Consensus at -77.10B compared to -80.20B in November.
02/10	14:30	Consumer Price Index (January)	This is the most important statistic of the week. Inflation is expected to rise again, to 7.2% compared to 7.0% in December. Pressure is increasing on the Fed to raise its rates.
02/11	16:00	University of Michigan Consumer Confidence Index (February)	Consumer confidence remains well-oriented, at 70.0 in February. This is an increase compared to the January estimate (67.2).