10.06.202600:49 Forex Analysis & Reviews: ECB Prepares for Rate Hike: Market Expects Decisive Action but Fears Uncertainty

On Thursday, the European Central Bank will hold another monetary policy meeting. The market almost unanimously expects a 25-basis-point increase in interest rates. Recent statements from members of the Governing Council suggest a notable tightening of rhetoric. If the eurozone economy does not show clear signs of slowing, the ECB's rate could reach 3% by the end of the year.

Particular attention will be paid to the press conference by ECB President Christine Lagarde. Investors will closely analyze her words since the agenda includes the ECB's readiness for further rate hikes at the next meeting in July. Since the June increase is already factored into current quotes and is unlikely to significantly affect them, a hint of tightening policy in July could strengthen the euro. Currently, the market estimates the probability of such a scenario at about 30%.

Market confidence in the rate hike was established back in April amid risks of accelerating inflation. Now, it has become evident that the rise in energy prices is becoming persistent and prolonged, which inevitably affects overall inflation.

The primary issue remains the uncertain economic outlook. The composite PMI index is below the growth zone, primarily due to weakness in the services sector. The manufacturing sector is still above the 50-point mark, mainly due to the fulfillment of orders accumulated before the onset of the conflict. However, the decline in new orders and reduction in employment indicate worsening underlying conditions.

Rising energy prices are reducing real household incomes and suppressing consumer demand. As a result, further declines in the manufacturing PMI index are almost inevitable in the coming months, which in turn will slow GDP growth. There is also a clear decrease in demand for labor, reflected in the slowdown of average wage growth.

The net long position in euros increased by a substantial $2.8 billion over the reporting week, with the calculated price trying to stabilize above the long-term average.

The EUR/USD pair successfully tested the support level at 1.1575, which had been considered the nearest target a week earlier; this move was triggered by a strong U.S. employment report. The anticipated ECB rate hike and the confident rhetoric from members of the Governing Council may support the euro in the short term and prompt a "bullish" pullback. However, the long-term probability of a trend reversal towards growth remains low.

Any significant growth will be limited by the resistance zone of 1.1670/90, where a resumption of selling is likely. A decline below 1.1500 is unlikely, at least until the results of the ECB meeting. However, if inflation data in the U.S. on Wednesday show a significant price increase, the dollar will gain momentum to strengthen, and the EUR/USD pair will quickly return to a downward trajectory.