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Greed leads to nothing good. The fears of investors missing out on the opportunity to make good money have allowed EUR/USD to rise above 1.1. Many felt the need to jump on the last train heading up, as the ECB continues aggressively raising rates and the Fed is uncertain whether one or two acts of monetary restriction will be required to complete the cycle. Euphoria is followed by realization. The Bank of England cooled the hot heads of euro enthusiasts.
With the acceleration of underlying inflation in Britain to 7.1% in May, the BoE, with 7 votes against 2, decided to raise the repo rate by 50 basis points to 5%. The overnight market raised its estimated peak to 6.25%. However, the pound did not rise. The market is seriously concerned that the central bank will push the UK economy into a recession. This circumstance clipped the wings of sterling fans and put pressure on European currencies.
Inflation dynamics in the U.S., the Eurozone, and Britain
The euro is no exception. Rather, it is the rule. Bundesbank President Joachim Nagel calls inflation a beast. He claims it would be a mistake to stop raising rates when it begins to slow down. The ECB should not step on the same rake as other central banks that prematurely ceased to tighten monetary policy. Their economies experienced a double recession. This refers to the experience of the Fed in the 1970s.
In any case, the futures market believes in a deposit rate hike by at least 4%. And the higher it goes, the worse it is for GDP. The German IFO Institute predicts a contraction of Germany's economy by 0.4% in 2023. The previous estimate was -0.1%.
Dynamics and structure of German inflation
We've seen this before. At the end of 2022, when the Fed aggressively tightened monetary policy and fears of an imminent downturn prompted investors to get rid of the U.S. dollar. At that time, bad news was good for stock indices as it increased the risks of Fed's "dovish" pivot. Conversely, strong statistics caused the S&P 500 to fall.
History repeats itself. It doesn't matter whether it's in Europe or the Americas. If the ECB goes too far with monetary restriction, a GDP contraction in the Eurozone is inevitable. And this can be a restraining factor, not only for members of the Governing Council, but also for bulls on EUR/USD.
However, for now, they dominate the market. Jerome Powell didn't surprise investors. They expected "hawkish" rhetoric from him, clear indications of two acts of monetary restriction by the Fed of 25 basis points each by the end of this year. Instead, they received the same vague formulations as after the June FOMC meeting.
Technically, on the daily chart, EUR/USD may form a pin bar with a long upper shadow. If this happens, the entry point for shorts will be 1.098. Pivot levels at 1.0975 and 1.0965 should also be used for selling. However, if the pair manages to hold above 1.0975, the risks of a continued rally and the recovery of the upward trend will increase. In such a scenario, one should consider transitioning to long positions.
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