In a recent analysis, Morgan Stanley underscores the European Central Bank's (ECB) emphasis on the powerful transmission of past rate increases to the euro area's financing and monetary conditions. Morgan Stanley's analysts note that the ECB hints at potential weakening of lending in the future based on its Q1 bank lending survey, which may lead to lower price pressures than currently anticipated. This, in turn, suggests the ECB might hike less than previously projected.

Morgan Stanley forecasts the Euro to weaken as market-implied ECB policy expectations diminish. Particularly, they highlight that banking developments in the euro area, especially as the ECB's balance sheet contracts rapidly towards the end of 2023, could lead the ECB to anticipate less future inflation.

Continuing their stance, they recommend maintaining short EUR/USD positions, setting a target at 1.03, based on the current financial dynamics and potential policy shifts.