Danske Bank anticipates that a 25bp rate hike by the European Central Bank (ECB) next week would likely cause a knee-jerk reaction in EUR/USD, pushing the pair higher by 1-2 figures. Despite this, the bank maintains a bearish stance on EUR/USD due to underlying growth and rate dynamics.

Key Points:

• Market Pricing: Given current market pricing, a 25bp rate hike by the ECB would likely result in an immediate, though possibly short-lived, uptick in EUR/USD.

• US Outperformance: Since mid-July, EUR/USD has been on a downward trajectory, influenced largely by strong economic data from the United States.

• Weak Overseas Growth: Poor growth prospects in the euro area and China have also been beneficial for the USD.

• US Yields: Upward pressure on US yields, especially from signs of improvement in the manufacturing sector, has also supported the USD.

• DXY Index: The DXY USD index recently reached its highest level since March of this year.

Trading Recommendations:

• Short-Term Trades: Traders might look for opportunities to capitalize on the knee-jerk reaction in EUR/USD should the ECB announce a 25bp rate hike.

• Long-Term Outlook: Despite the short-term potential for a EUR/USD boost, the underlying fundamentals support a bearish stance on the currency pair.

Implications:

For Traders:

• Tactical Opportunities: Consider taking positions that could benefit from a brief surge in EUR/USD following the ECB rate hike.

• Risk Management: Those maintaining long-term bearish positions on EUR/USD should be prepared for short-term volatility.

For Policymakers:

• Rate Differentials: Policymakers should note that relative rates between the ECB and the Federal Reserve could influence the EUR/USD pair in the near term.

Conclusion:

Although Danske Bank expects a knee-jerk reaction pushing EUR/USD higher following an anticipated ECB rate hike, the bank remains bearish on the currency pair due to stronger economic performance in the U.S. and weak growth prospects in the euro area and China. Traders may find short-term opportunities but should be cautious due to underlying bearish fundamentals