The European Central Bank's policymakers are sounding increasingly hawkish but even if they match heightened expectations and raise rates 95bps by year-end, the gulf with U.S. interest rates will weigh on EUR/USD. nL5N2X822G
If the eurozone central bank's deposit rate were to reach 50bps at the end of 2022 there will be a big gap with U.S. interest rates which are expected to rise closer to 3 percent.
Despite this large interest rate differential, traders are betting EUR/USD rises. nL2N2X80A2 Economists predict a big rise in the next twelve months nL2N2X80BB and option traders are relatively unconcerned about a deeper drop, holding scant cover for a move below parity. nL2N2X80AY
When the Federal Reserve last raised interest rates by the same magnitude between 2015-18 it laid the foundation for a carry trade that drove EUR/USD from 1.2556 in 2018 to 1.0636 in March, 2020.
The rally which preceded that rise was driven by expectation of ECB tightening which squeezed EUR/USD shorts resulting from the euro zone crisis.
With traders currently betting on a rise, there is much less chance ECB policy can inspire a rally.
As a result, the following drop should begin from a much lower base and could extend far below parity. nL2N2X80C5
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