Dollar hit by signs of stagnation in US; Euro performs mixed after ECB 'hawkish' surprise

Euro

The ECB surprised the markets with a 50 basis point rate hike. We had estimated the chance of this happening at 50%. The initial positive reaction from the euro faded a bit, as markets still feel they don't know enough about the ECB's 'anti-fragmentation tool'. Incidentally, the ECB is discontinuing its forward guidance and will rely less on its own forecasts. This step is urgently needed because, as we have said on many occasions, these forecasts are completely inadequate. This uncertainty, combined with the negative surprises from the PMIs – which seem to indicate that the eurozone economy is stagnating – prevented the euro from further increasing its gains against the dollar and brought parity into sight. All eyes are now on Friday's flash CPI numbers. Core inflation in the euro area is not yet expected to have peaked.

British Pound

Macroeconomic news from the UK improved markedly last week. The reports on economic activity were upside surprises and continue to point to stable growth. On the labour market, healthy job creation continued in May. Headline inflation is still sky-high, but core inflation has been falling for two months in a row now. The British pound hardly reacted to this and followed the exchange rate of the euro against the dollar. Still, all this positive news could cause the pound to rally in the coming weeks, especially with valuations remaining good.

U.S. Dollar

There were unmistakable indications last week that the U.S. economy is stagnating. Weekly claims for unemployment benefits continue to rise – but from a very low level. High mortgage rates are still causing stagnation in the housing market, but the number of new housing projects remains historically high. The most worrying development, in our view, is the decline in PMIs to levels that clearly point to contraction. Central banks around the world have delivered hawkish surprises, but we don't expect the Federal Reserve to do so at its July meeting this week. There are indications that the US economy is stagnating, which should be sufficient reason for the Fed to limit the rate hike to 75 basis points. In general, we think that the extreme rate hikes are now a thing of the past and we will see the familiar 25 or 50 basis point hikes again after the July meeting. This could put an upper limit on the dollar's gains.