Euro Rebound on the Cards as ECB Signals Further Tightening

Talking Points:

• The expectation of further hikes from the ECB should keep the Euro well-bid against the Canadian Dollar and British Pound.

• A Bull Flag formation below key resistance suggests an upside breakout is on the cards for the EUR/CAD exchange rate.

The Euro has strengthened against most of its peers in recent weeks as persistently high inflation in the Euro-zone area forces the European Central Bank to continue tightening its monetary policy settings. A 50-basis point is almost a certainty at next week’s Governing Council meeting following President Christine Lagarde’s pre-announcement at last month’s meeting and a core inflation rate that has continued to increase despite the central bank raising its rates to the highest level in over a decade. Moreover, a hike of the same magnitude is expected in May as several members of the ECB flag that rates will have to continue rising and remain elevated for some time to bring inflation back to target. After all, core inflation hit a fresh record high of 5.6% in February and looks like it is yet to hit its peak.

Euro-Area Core Inflation Rate

However, headline inflation – which takes into account more volatile components such as energy and food – has declined faster than expected and will continue to do so as energy prices head south. At the same time, there are growing signs that the trading bloc’s economy is stagnating and on the verge of entering a technical recession, with expectations of GDP growth in both Germany and Ireland being revised down. This could give some weight to the argument of ECB doves, like Chief Economist Phillip Lane, who have argued that a more cautious approach is needed and that a pause in the rate hiking cycle should occur in the coming months. That said, this scenario appears unlikely given inflation is far higher than the ECB’s mandated target. With that in mind, the Euro may continue outperforming those currencies that have a more dovish central bank, such as the Canadian Dollar and British Pound.

EUR/CAD Daily Price Chart – Bull Flag Formation Points to Higher Highs

From a technical perspective, the outlook for the EUR/CAD exchange rate remains bullish as prices consolidate in a Bull Flag formation just below key psychological resistance at the 1.4600 handle

With price continuing to respect the uptrend extending from the August 2022 lows, the path of least resistance seems skewed to the upside.

A daily close above 1.4640 is needed to validate bullish potential and carve a path for price to charge towards the September 2021 highs. However, if sellers can breach uptrend support, a pullback towards the February lows could be on the cards.

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