04.12.202212:13 Forex Analysis & Reviews: The European Central Bank does not know how to proceed with interest rates

The euro hit new monthly highs against the U.S. dollar, but recent statements by central bank representatives, including European Central Bank President Christine Lagarde, will limit its growth potential.

Lagarde said that inflation expectations should remain unchanged and that the public should be firmly convinced that prices will return to the central bank's target level. "Given this exceptional uncertainty, what we central banks have to do is actually deliver monetary policy that anchors expectations so those expectations remain moored to target," she said in Bangkok on Friday. "We need to signal to the public, to the observers, to the commentators, that in all scenarios, inflation will return to our medium term, which is the best we can do in the current environment," Lagarde added at a conference organized by the Bank of Thailand and the Bank for International Settlements.

Obviously, if we have sorted out the Federal Reserve before the end of the year, then investors are now focused on the last ECB meeting of the year, which will be held on December 14-15. Officials will decide whether to raise interest rates for the third consecutive time by 75 basis points or whether it is best to resort to and soften the rate hike to 0.5% following the Fed's example.

A little earlier this week, Lagarde said she would be surprised if rate hikes peaked. Meanwhile, some of her hawkish ECB colleagues are warning against prematurely intervening in plans to regain control of inflation. According to the latest Eurostat data, inflation dipped to 10% in November, which was below economists' forecast of 10.4%. The drop from 10.6% in October was the largest since 2020 and was due to slower increases in energy and services prices, even as food prices rose faster. This development, although good for the economy, raises doubts about the euro's succeeding growth, which enjoyed expectations of continued aggressive policy from the ECB.

Lagarde also warned that the economic outlook will remain uncertain in the near future, as the European economy is going through a very difficult time right now. She also turned her attention to the foreign exchange market, saying the central bank is not focused on any exchange rate. "Obviously, we are monitoring and are very attentive to variation of exchange rates, and in particular we are monitoring closely what has caused the growth of the dollar, but we don't have any panic about the decline of the European currency," Lagarde said.

"Fiscal policies that create excess demand in a supply constrained economy might force monetary policy to tighten more than would otherwise be necessary, and regrettably, at the moment, at least some of the fiscal measures that we are analyzing from many of the European and particularly euro area governments are pointing in the direction of the latter category," she said, referring to measures that could trigger excess demand.

Recall that most recently, speaking at the Brookings Institution in Washington, DC, Fed Chairman Jerome Powell hinted that the US central bank would raise interest rates by 50 basis points at the December 13-14 committee meeting after four consecutive hikes of 75 basis points. "The time for moderating the pace of rate increases may come as soon as the December meeting," Powell said. "Given our progress in tightening policy, the timing of that moderation is far less significant than the questions of how much further we will need to raise rates to control inflation," he said, "and the length of time it will be necessary to hold policy at a restrictive level."

It is only a matter of time until the ECB follows the Fed's lead.

As for the technical picture of EURUSD, the demand for the U.S. dollar continued to fall, which once again resulted in the euro strengthening, maintaining sufficient growth potential at the beginning of this month. In order to rise further, the euro needs to climb above 1.0540, which will fuel the single currency to rise to the area of 1.0570. Above this level it is easy to climb to 1.0610. In case it falls, failing to support 1.0495 will push EURUSD back to 1.0450 and increase the pressure on EURUSD with the prospect of a fall to the low of 1.0395.

As for the technical picture of GBPUSD, after Thursday's sudden surge of more than 200 pips, the bulls will try to maintain control over the market. To do so, bulls need to rise above 1.2250. A breakthrough of this range will strengthen hopes for pushing the pair to 1.2300, after which it will be possible to speak about the pound moving to the area of 1.2340. There is talk about the pair being under pressure after the bears take control over 1.2180. This will deal a blow to the bulls and push the GBPUSD back to 1.2110 and 1.2045.