The ECB's Gamble: Tightening When Growth Falters

The macro point

Eurozone inflation climbed to 3.2% in May, its highest level in more than two and a half years. On the growth side, the first quarter GDP, revised on Friday by Eurostat, stands at -0.2%, compared to +0.2% in the previous quarter. But be careful not to overinterpret this figure: the shift into negative territory is almost entirely due to Ireland, whose GDP collapsed by 12.1% over the quarter, a number notoriously distorted by pharmaceutical multinationals, with little connection to the real economy. Excluding Ireland, the picture is different: Germany and Italy are growing by 0.3%, Spain by 0.6%, only France is slightly declining. Let's be clear: this is not a recession, but a stagnation darkened by a statistical artifact. The nuance matters because it changes the reading of the ECB's move.

This inflation is primarily of an energy origin. The conflict in the Middle East has strained the oil market, and Europe is suffering from an imported bill over which it has little control. There lies the dilemma: monetary policy acts on demand, not on supply, and a rate hike will neither bring down the price of a barrel nor reopen the Strait of Hormuz. The doves draw a logical conclusion: the energy bill is already weighing on household consumption, so inflation should subside by itself.

The hawks take a more worried view. The acceleration of core inflation and services suggests that tensions are now spreading beyond just energy, with the risk of affecting wages. To them, Thursday's tightening is primarily insurance against this scenario. Between these two readings, the ECB has not truly decided, leading it to proceed on a ridge line.

For companies exposed to exchange rates, the main point is elsewhere: this rate increase does not benefit the euro, and it is important to understand why. The Fed, firstly, has stopped considering rate cuts. The US employment report for May, with 172,000 new jobs compared to the expected 85,000, even led the market to anticipate a transatlantic hike by the end of the year.

Technical point

The EUR/USD closed Friday around 1.152, erasing its gains for the week after the shock of the US employment report. The pair is now at its lowest since early April, approaching the annual low of 1.1411 reached in mid-March. The key lies beneath the surface: with a Fed seen tightening again and US inflation expected around 4.2%, the differential in real rates remains favorable to the greenback. Add in the geopolitical risk premium, and you have the real drivers of the pair. Watch the 1.1480 zone: breaking it would reopen the path to 1.1435, then 1.1400. In the short term, we see the EUR/USD trapped between 1.1430 and 1.1630, with the outcome depending less on raw figures than on the tone of central bankers.

The Swiss franc plays its safe-haven role. The EUR/CHF stands around 0.9170, with the franc attracting cautious flows without the SNB even having to intervene. As long as geopolitics is a troublemaker, it will remain sought after. The yen, meanwhile, is caught in a bind: EUR/JPY moves around 185.0, torn between the safe-haven appeal of the Japanese currency and an interest rate differential that remains unfavorable.

Regarding commodity currencies, the Canadian dollar benefits from firm oil prices, with EUR/CAD oscillating around 1.6160. Be careful though: the Bank of Canada announces its rate decision on Wednesday, and a surprise could reshuffle the cards.

The supports and resistances displayed below indicate the lows and highs within which the prices should move during the week.

Announcements to follow

Start of the week without relief, end of the week under high tension. Three meetings will structure the market: US inflation on Wednesday, the Bank of Canada the same day, and then the ECB's verdict on Thursday. The peacemaker is US inflation. A figure above the 4.2% consensus would confirm the scenario of a constrained Fed tightening and would further weaken the euro even before Lagarde has spoken.

On Thursday, the market will not react to the ECB's rate hike announcement, which is already fully priced in. The question is whether Lagarde will validate a second hike in September, or leave an exit open given the slowdown. This is the whole point of the press conference. Additionally, US Producer Prices (PPI) the same day, then German inflation and Michigan confidence on Friday, will complete a particularly dense picture.

The information presented in this publication is communicated to you for informational purposes only and does not constitute investment advice, an offer to sell, or a solicitation to buy, and should not be used as a basis or considered as an incitement to engage in any investment.