as the USD and CAD over the coming quarters. The EUR may, however, gain some ground against currencies like the GBP and AUD, with markets anticipating even more misplaced hiking bets for their respective central banks. Eurozone CPI rose by 7.5% y/y and 2.5% m/m in March according to data published today. The trend in prices may soon see inflation double the financial crisis high of 4.1% y/y, with Spain, for instance, likely to reach double-digit inflation in April. Although the bulk of the surge in prices relates to elevated energy costs (and increases in regulated prices in countries like Italy), Eurozone core CPI also rose by 3.0% last month—its highest since the mid-90s based on pre-Eurozone data.
Government measures aimed at easing the pain of international commodity prices in France have translated into more modest price rises there, with inflation coming in at 5.1% y/y. Despite the macroeconomic risks posed by the war and its associated impact on commodity prices—and thus real incomes and spending—OIS markets are back to expecting two 25bps hikes (and then some) from the ECB by the year-end; hike bets had sharply declined in the days following the Russian invasion to less than 10bps in early-March. With the bank indicating that it will not hike rates until it has concluded its APP, traders are anticipating the first 25bps hike in September followed by another increase in December. Our latest economics department’s forecast projects a first increase in Q1-23, but we think one 25bps hike in Q4-22 is increasingly likely and a more pronounced building of wage pressures and persistent core prices increases could motivate the ECB to tighten twice this year. However, we think that’s probably as much as the bank will tighten by December, and odds are it still chooses to go with only one 25bps increase, particularly as inflation eases from elevated levels in H2-22 and the pressure to act is lessened. The 100bps+ in hikes that markets are anticipating by the April 2023 ECB meeting would be an especially accelerated pace of tightening that the ECB is unlikely to meet, as well. With limited room for more hikes from the ECB over the coming year than what markets are anticipating, there are no major EUR tailwinds for the quarters ahead aside from a marked decline in energy prices alongside a Ukraine war ceasefire. Even with a détente, the Eurozone is bound to face high energy prices that limit growth with sanctions on Russia maintained and the bloc meeting a higher share of its energy needs from other, costlier sources. With markets, and some economists, anticipating that the Fed and the BoC will hike to 3% next year, yield differentials will remain an important drag on the EUR against the USD and the CAD—with EUR losses heading to 1.08 and 1.35 against these currencies, respectively. The EUR may fare better against the GBP, however, since markets have placed even more unlikely bets on BoE hikes this year, seeing a policy rate of 2-2.25% by end-2022—at least 75bps higher than BoE guidance suggests. Here, EURGBP looks set to climb to 0.87, at least, in coming weeks as the BoE douses tightening expectations. An easing of overextended RBA expectations and a possible normalization of commodity prices should also help take EURAUD back above 1.50 while a very dovish SNB and an overvalued franc against the EUR points to the EURCHF targeting a test of 1.06.
