28.10.202207:52 Forex Analysis & Reviews: EUR/USD post-ECB meeting

By the close of the trading week, everything has fallen into place.The US dollar is going north again. Meanwhile, the euro is still hovering somewhere in the south. A recession in the United States ended without even starting. Meanwhile, the ECB hawks are not ready to raise interest rates too aggressively, fearing it might harm the already weak economy.

Nevertheless, sentiment is still as combative as it can be. It all looks rather odd. In its statement, the ECB implied that borrowing costs are approaching the neutral interest rate fast. At the same time, the regulator stressed the need to further increase its benchmark interest rates in the coming months.

Anyway, the economy remains the ECB's top priority. Meanwhile, a sharp increase in interest rates seems to be a catch-up attempt.

The European regulator used to be less hawkish. Meanwhile, broad signs of a decrease in economic activity in the eurozone align with a 0.50% rate hike in December, especially if inflation slows down a bit. This would be a minor negative factor for the euro. The EUR/USD pair pulled back from the parity level, following the ECB meeting. Still, the quote may get back to 0.9800.

Overall, the euro is unlikely to reach 0.9300 by the end of the year.

There is an alternative interpretation of the ECB's decision. We cannot deny the fact that world central banks are now more prone to slow down the pace of rate hikes. Such decisions already came from the Bank of Canada and Australia's Reserve Bank. On Thursday, the ECB also hinted at such a possibility, and it seems the US Fed will not be an exception either.

The US central bank made it clear recently that after a 0.75% rate increase in November, markets will get a signal about a further slowdown in the pace.

The greenback will definitely react to it with a fall. A plunge in the dollar value this week shows how sensitive the currency is to such news. On Thursday, the US dollar index bounced off its 3-week lows.

Next week is likely to become a turning point. If market players turn out to be right and the regulator somewhat eases its aggressive monetary stance, the greenback may enter a correction after a one-and-a-half-year-long rally.

Are there any reasons for concern?

Core inflation in the US grew to 6.6% from 6.3% in September. At the same time, the inflation rate is firm at 8.2% year-over-year. Inflationary pressure remains high, meaning the Fed's fight against inflation is far from being over. Therefore, interest rates might be raised by another 150 basis points and reach the rate of 4.5% at the end of this year and 4.75% in early 2023.

This would be enough to cause a significant decrease in consumer spending by constantly slowing inflation. At the same time, the economy may or may not slide into a recession at the beginning of 2023.

A row of fresh data shows that economic activity increased in the third quarter, which means a technical recession is no longer the case in the country. Still, recession risks are likely to stay high in the coming months due to the Fed's interest rate policy.

For the first time this year, GDP accelerated. It rose by 2.6% in the third quarter, following a 0.6% fall in the previous quarter, marking the end of a technical correction that started at the beginning of the year.

Still, various economic sectors produce different results. Thus, the housing market was one of the first to react to the Fed's aggressive tightening. Retail sales also declined due to a fall in demand. This leads to significant stockpiling in convenience stores and reduced inventory investment among retailers.

Although growth in the third quarter was impressive, the economy is facing mounting headwinds both at home and abroad. They are the energy crisis in Europe, economic woes in China, and the Fed's rate-hike cycle.

As a reminder, the US regulator has raised interest rates five times since March. The Fed also warned in September that it saw the federal fund rate at 4.5% by the end of the year and at 4.75% next year.

Rising borrowing costs across the economy and a strong US dollar are causing powerful headwinds. Meanwhile, weak external conditions amplify downside risks, ING said.

Despite the fact that a technical recession in the US is over, the situation is still rather unstable, and high recession risks remain.

Therefore, the US still may face an economic downturn at the beginning of next year.