Russia's special military operation in Ukraine has not only increased volatility in the markets of stocks, bonds, commodities and currencies, but also confused the cards of leading central banks, which, on the one hand, are aimed at curbing inflation, and on the other – fear the consequences of events unfolding in eastern Europe. Recently, European Central Bank representative Robert Holzmann complained that the eurozone economy would be on a remarkable growth path if it were not for the conflict between Kiev and Moscow. Following the results of the March meeting, the central bank lowered the forecast of GDP growth of the currency bloc to 3.7% for 2022 and to 2.8% for 2023. In the previous December forecast, the indicator was expected to grow by 4.2% and 2.9%, respectively.
At the same time, the ECB has seriously raised the inflation estimate in the eurozone for the current year to 5.1%. According to the previous estimate, it could be 3.2%. According to Holzmann, the central bank could send a clear signal to fight inflation by raising interest rates before ending its stimulus program of bond purchases. The ECB plans to complete asset purchases in the third quarter, accelerating its exit from the emergency monetary stimulus regime.
Money markets expect interest rates in the eurozone to rise by almost 50 basis points by the end of the year, which is equivalent to five increases of 10 basis points. Holzmann's comments run counter to the ECB's long-standing opinion on the sequence of its policy steps, and also challenge the previously voiced statements of the head of the central bank, ECB President Christine Lagarde, that the financial institution left rates unchanged this month and will not rush to raise them.
Lagarde believes that in the medium term, inflation in the eurozone is likely to stabilize at the level of the central bank's target of 2%. At the same time, Lagarde does not see the risks of stagflation – recession in the economy against the background of high growth rates of consumer prices – even if the worst scenario of events in Ukraine materializes. "Even in the darkest scenario – with unexpected consequences, an oil and gas embargo, and the deterioration of the military situation for a long time – even in such a scenario, we expect economic growth of 2.3%," she said on Monday.
A similar point of view was voiced on Tuesday by ECB Vice President Luis de Guindos. The eurozone economy will continue to expand even if the conflict in Ukraine escalates, he said. "Thus, for now we can rule out the possibility of stagflation, because even in the weakest scenario, we expect eurozone GDP growth of about 2% in 2022," Luis de Guindos said. He added that while high energy prices are pushing inflation to record highs, there are no signs yet that inflation expectations are starting to rise or come off the anchor. ECB officials admit that the conflict between Kiev and Moscow will have a significant impact on economic activity in the region, but they consider European inflation not such an acute problem as their colleagues from the United States.
This week, Federal Reserve Chairman Jerome Powell downplayed concerns about the potential burden on economic growth and suddenly focused all attention on the likelihood that the conflict in Ukraine could spur inflation in the United States, which has already reached a 40-year high and is about three times higher than the 2% target set by the central bank. It is noteworthy that just two weeks ago it seemed that Powell was seriously concerned about the economic situation amid strong concern about the consequences of the Russian-Ukrainian conflict. The last time the position of the chairman of the US central bank changed so sharply was when he stopped using the term "transient" to describe inflation at the end of last year. Then Powell has been downplaying the importance of inflationary pressures in the country for months.
The latest changes in the views of the head of the Fed may reflect his ongoing personal hawkish turn, which began at the end of 2021, NatWest analysts say. "In the short term, the comments of Powell's comments are obviously not the last word on the scale of the expected rate hike in May, especially given that the May FOMC meeting will take place only in six weeks, and the Fed's actions will be determined by the data," they said. According to experts, Powell's comments may also reflect a broader view within the Committee that rates could rise quite a lot and not push the economy into recession.
Fed policymakers signaled Wednesday that they may take more aggressive actions to lower inflation, including a possible half-percent interest rate hike at the next policy meeting in May. "If we need to raise the key rate by 50 basis points, then we will do it. With such a strong labor market, inflation is on everyone's mind," said Mary Daly, president of the San Francisco Federal Reserve. She believes that the Fed should gradually raise the rate to a neutral level and, perhaps, even slightly above this level in order to limit economic growth and reduce inflation.
The head of the Federal Reserve Bank of Cleveland, Loretta Mester, in turn, said that she wants the rate to rise to about 2.5% by the end of the year, a level that she considers neither retarding nor stimulating the national economy and which will require some rate increase by 50 basis points. Money markets have adopted this point of view and have included in the quotes two increases in the federal funds rate by half a percent at the upcoming FOMC meetings, as well as a range of interest rates at the end of the year of 2.25%-2.5%. "A sharp hawkish revision of expectations for a Fed rate hike will mainly benefit the dollar compared to low–yielding currencies, whose central banks will lag far behind the Fed in tightening policy," MUFG Bank strategists believe.
The hawkish comments of the Fed representatives supported the greenback, which managed to take advantage of the flight of markets to safe havens on Wednesday and closed in positive territory. Following the results of yesterday's trading, the USD index rose by 0.15% to 98.60 points. Meanwhile, weak statistical data on the eurozone and a risk-averse market atmosphere put pressure on the single currency, which fell by more than 0.2% against the US dollar the day before, to $1,1005. According to the European Commission, the consumer confidence index in the currency bloc in March, according to preliminary estimates, fell to -18.7 points from -8.8 points recorded in February.
The comments of Ignazio Visco, a member of the ECB Governing Council, did not add optimism to the single currency. He said that the situation in the eurozone is very different from the United States, where household disposable income has grown sharply, and monetary policy can only be restrictive. "There is no demand shock in Europe, there is a supply shock. Inflation expectations are well fixed at about 2%," Visco said. "The world we need to move into is a world without negative real interest rates. However, there is currently no need for quick action," he added.
The euro weakened further after the statement of Russian President Vladimir Putin that Russia is converting payments for gas supplies to unfriendly countries into rubles. "This statement highlights the continuing risk of further destruction of the European economy due to the conflict in Ukraine. A more protracted conflict will have a stronger impact on the single currency," MUFG Bank believes. In addition, the adviser to the President of Ukraine Vladimir Zelensky said on Wednesday that Kiev expects the end of the active phase of the military conflict with Russia by the end of April. These comments did not help improve market sentiment and put additional pressure on the EUR/USD pair.
ANZ Bank believes that in the coming months, the main currency pair will trade in the 1.0500-1.1500 range, with a downward bias. "The shock to the energy supply of the eurozone and the urgent need to dissociate from Russia, a sharp deterioration in the terms of trade in the region and increased disruptions in the supply chain – all this has a negative impact on the European economy," the bank's analysts said. "We have reduced our forecast for eurozone GDP for 2022 to 1.5% and expect the region to lag behind the US in the global growth rating. We remain very attentive to the potential for price fluctuations as the market reacts and expects more certainty. Thus, in the coming months, the range of 1.0500–1.1500 may prevail for the EUR/USD pair. At the same time, the pair may trade lower for longer," they added.
The cautious attitude of the players allows the dollar to remain strong against its main competitors on Thursday. The USD index is again rushing to the 99.00 mark, rising by 0.2% and maintaining an upward bias. The EUR/USD pair is still having difficulty overcoming the bearish pressure, trading below 1.1000. A two-day EU summit with the participation of US President Joe Biden starts today in Brussels. According to the President of the European Council Charles Michel, the central theme of the summit will be the events in Ukraine. Although the most unexpected decisions are possible, Western leaders will probably refrain from sending NATO peacekeepers to Ukraine or supplying anti-missile systems there. Most likely, the alliance will continue to increase its military presence in the region for the time being. Meanwhile, the negotiation process between Kiev and Moscow will continue, albeit not without some pause, which may be needed to reflect on the decisions made from Brussels.
It is necessary to see what exactly the US and the EU will decide today and tomorrow in terms of further measures and sanctions against Russia. The United States is expected to announce additional measures, but the EU is not going to impose large new sanctions. In general, the euro will remain under pressure, according to Commerzbank. "The fact that the US wants to reach an agreement with the EU that will reduce Europe's dependence on Russian gas supplies may indicate that pressure on the alliance to impose sanctions on energy supplies from Russia is increasing, which is still being resisted by several EU states. They would probably prefer only the tightening of existing sanctions," the bank's analysts said. "Russia can raise energy prices and greatly harm the EU economy, even if it continues to supply gas. Therefore, we think that with each new batch of sanctions, the risk of an energy price shock increases, which will hit the EU economy and, consequently, the euro harder. Accordingly, the risks for the single currency remain downward at the moment," they added.
The EUR/USD pair will continue to lose ground in the coming weeks, HSBC strategists predict. "In addition to geopolitical events, the prospects for monetary policy in the eurozone may put pressure on the EUR/USD pair in the coming weeks. The ECB leadership is likely to maintain a predominantly dovish mood ahead of the April 14 meeting, emphasizing the likely pause between the end of QE and the first rate hike," they noted. Technical indicators also hint at a bearish bias of the main currency pair in the short term. In particular, the relative strength index (RSI) dropped below 50. In addition, EUR/USD is currently trading below the 100-day moving average, confirming the lack of interest from buyers.
The nearest support is located at 1.0960, and further - at 1.0940 (the Fibonacci correction level is 23.6%). In case of a breakout of the last level, the pair may accelerate the decline to the psychologically important 1.0900 mark. On the other hand, the initial resistance is at 1,1000 (100-day moving average). Above this level, the next obstacle occurs at 1.1020 (50-day moving average) on the way to 1.1040 (50% Fibonacci retracement level).
