In recent months, the EUR/USD has risen from 1,04/1,05 to 1,18, an appreciation of the euro of more than 13%. Is that increase the start of a prolonged climb of the EUR/USD? Or should we prepare for a declining phase?
If we want to answer that question, two things are crucial. One wonders to what extent the Fed chooses to continue following its current path, namely 2 interest rate increase this year and 1 more in the coming year. Secondly, there is the question of how quickly the ECB will phase out the policy of quantitative easing.
With regard to the Fed, the market has already raised many questions about the 4 interest rate increases between now and the end of 2018. The ECB is expected to start phasing out its QE policy from the end of December. The plan is for complete dismantling in the summer.
The Fed kept monetary policy unchanged in July, but the bank also made it clear that future policy will depend mainly on the development of inflation in the United States.
Heated debate
Inflation in America has fallen considerably in recent months, after rapidly rising to 2% earlier this year. Initially, this decline worried the Fed, because the bank assumed that this would be a temporary phenomenon. However, now that inflation has been falling for longer, the Fed is starting to become more restless. More and more members of the interest rate committee are wondering whether this will not become structural after all.
The minutes of the meeting show that there is a heated debate within the Fed's interest rate committee. Is the decline in inflation structural or should it be ignored? That is the question being asked. Many members expect that US inflation will remain below the target rate of 2% to 2,5% for longer. In the meantime, this group is even wondering whether inflation in the US will rise again at all in the coming years.
The above is very important. This is because raising interest rates while inflation is below the target rate and under downward pressure would not make sense. After all, interest rate increases would actually push inflation down further. The Fed wants to prevent that. That is why it would not surprise anyone if the Fed still decides to take a standstill for the time being.
In short: the inflation figures, which will be published in the near future, will determine the Fed's path.
New estimates
The coming month is also important in the eurozone. The ECB economists announce their new forecasts for inflation in the euro zone in 2018 and 2019. It is these predictions that are very important for what the ECB board will do with interest rates.
If these forecasts indicate that inflation will be further away from the target rate up to and including 2019, then one can expect that the ECB will reduce its purchase of government and corporate bonds more slowly. On the other hand, one can also expect interest rate increases in the eurozone to shift even further into the future.
How could all this play out for the EUR/USD? The belief that the Fed will raise rates less quickly than expected should keep the EUR/USD under upward pressure.
Climb over?
However, at the same time there is an increasing chance that the ECB will take longer to phase out its QE policy and that the first interest rate increases will be even further in the future. Those 2 events could push the EUR/USD down further. If the euro crisis flares up again (Italy is the problem child of the euro zone and the situation there could easily explode), this could put additional downward pressure on the EUR/USD. In addition, neither the Fed nor the ECB are looking for a stronger dollar or a stronger euro, respectively.
All in all, it seems most likely that the EUR/USD will come under slight downward pressure on balance in the coming months. In that slight correction, a decline towards 1,12/1,10 is quite possible. The month of September is important for both the Fed and the ECB, so we have to wait and see before we can expect a clear answer.