Higher rate expectations to boost Euro

The Euro turned a corner at the start of the year against the US Dollar after reaching parity a little time earlier but fast forward until today and the European currency has given up all of its gains since early January. The key to any further gains against the greenback will be the inflation figures and how expectations pan out as the year unfolds.

ECB board member Isabel Schnabel and French central bank chief Francois Villeroy de Galhau, two of the most influential voices on the 26-member Governing Council, both highlighted their fears about stubborn underlying inflation and pushed back on market pricing for interest rates.

Both believe inflation in the Eurozone will stay higher than expected for longer than is currently priced into financial markets which will cause the ECB to hike interest rates the original predictions. Money markets now show investors betting on a peak ECB rate at around 3.75% by late summer, up from levels around 3.4% earlier this month, as a string of hawkish ECB comments in recent days unwound earlier bets.

"Markets are priced for perfection. They assume inflation is going to come down very quickly toward 2% and it is going to stay there, while the economy will do just fine. That would be a very good outcome," noted Mrs Schabel.

"But there is a risk that inflation proves to be more persistent than is currently priced by financial markets. As regards the terminal rate, we need to look at the incoming data to see how far we need to go," she added.

Looking further ahead today, the main drivers of the EUR/USD currency pair will be a monetary speech from ECB president Christine Lagarde where she is expected to reiterate the European Central Banks plans to hike interest rates by 50 basis points next month.

In the American session market participants will await the release of the S&P Global Manufacturing PMI index from the US for the month of February as well as the existing home sales figures where a slight rebound is expected from last month and may provide some support to the US dollar.