Euro not backed by ECB, the EUR/USD exchange rate returns to parity (Daily analysis 28.10.2022)

Financial markets remain volatile. Indeed, the panic of the turn of September and October in the past few days has given way to euphoria. The zloty was one of its main beneficiaries in the past week, with the dollar and the franc becoming the biggest victims. In just over a dozen days, the euro rose by almost 5% against the dollar and equalled the value of the US currency. However, the EUR/USD has retreated by more than 1% from its local peak of 1.01. This is the aftermath of the ECB meeting: a second consecutive 75 hike is not enough to sustain demand for the euro.

Euro: rates in eurozone up again sharply

The European Central Bank raises interest rates by 75 basis points for the second time in a row. As a direct result of the decision, which is in line with market forecasts and valuations, the deposit rate, which was still -0.5% in June, is being raised to 1.5%. Today's decision will result in the highest cost of money in the eurozone since 2008, the middle of the Global Financial Crisis.

Europe's economy may contract in 2023, and consumption will stagnate. Although gas prices have plunged in the past weeks, the threat of an energy crisis in Europe cannot be underestimated. The bleak scenarios seem to be confirmed by the economic barometers. On Monday, the PMI index for industry and services declined for the sixth consecutive time. As a result, it takes on the lowest values in almost two years, heralding a regression. Despite this, the Governing Council is looking through its fingers at the black clouds continuously looming over the eurozone and is continuing its aggressive tightening. All, of course, because of inflation, which in September touched 10% and was the highest in the eurozone's history.

Euro: the EUR/USD rally halted by the ECB

Europe's monetary authorities are trying to keep a face that confirms their full determination to tackle the record rise in prices but have not allowed themselves to declare that the next rate moves will be just as strong. Decisions on the scale of tightening are to be made from meeting to meeting, meaning that the bank has backed away from announcing a series of hikes. The Governing Council also felt it was too early to enter into difficult discussions about the future of the balance sheet total. The emergency tools of the time of the pandemic crisis, mainly asset purchases, have inflated it from around 4.7 to an astronomical value of more than 8.8 trillion EUR.

Only a change to the terms of the TLTRO III low-cost loan programme was announced to induce banks to repay them early. Prior to today's meeting, rates were expected to rise by a further 1.25 percentage points in total at the next three meetings (December, February and March). This is a very high bar of expectation that is difficult to meet, all the more so in view of the recent, very dynamic improvement in the condition of the single currency.

Dollar: Fed meeting may erase USD drops

This sudden turnaround in currencies, as well as in equity markets and the bond market, is due not only to the fading of fears over the gas crisis but also to the renewed hope that an end to the tightening cycle in the United States may be on the horizon. Although the Fed will raise rates for the fourth time in a row by 75 basis points (to the highest range in a dozen years, 3.75-4.50%) next Wednesday (at 7 p.m. CET), investors are hoping that this will be the last such abrupt move and that the hikes will end by early 2023.

However, as in August, these hopes may be misplaced, and enthusiasm will again evaporate in the blink of an eye and give way to an unfavourable minor investment sentiment for emerging markets. After all, Fed policymakers are keeping a tight stance in their statements, core inflation reached a forty-year peak in September and the labour market is red-hot. Moreover, the most recent data showed that, after two quarters of negative GDP growth, the US economy grew by as much as 2.6% (annualised) in the third quarter with a high consumption score against forecasts. What may be putting the handbrake on the rebounding equity markets is a series of disappointing quarterly reports and signals coming from US tech giants upon their release. This week has seen disappointments from parent companies Google (Alphabet) and Facebook (Meta) as well as Microsoft and Amazon.