Euro: ECB support limited by spreads – NBC

National Bank of Canada ’s (NBC) Stéfane Marion and Kyle Dahms note the Euro (EUR) fell toward 1.13 in June despite a more hawkish European Central Bank (ECB), underscoring that EUR/USD remains driven by relative rates. Widening 2-year Bund–Treasury spreads weigh on the pair, while speculative positioning is now more balanced. They target EUR/USD at 1.18 by year-end, assuming broad Dollar moderation as Fed repricing matures.

Euro needs Dollar relief

"The euro has weakened despite a more hawkish ECB, reinforcing that EUR/USD remains mostly a relative-rates story. Short-term spreads have moved against the common currency, while softer inflation reduces the need for a more aggressive ECB response. Still, positioning is now less stretched than a quarter ago."

"In the near term, the euro still needs dollar relief to reach our year-end target."

"Short-term yield spreads remain the clearest headwind. The 2-year Bund-Treasury differential has moved materially against the euro in recent weeks, helping explain why EUR/USD weakened even as the ECB tightened policy. Until that spread stabilizes, the near-term path for the euro is likely to remain choppy."

"We therefore continue to see the euro’s path as mostly a USD story. Our year-end target is 1.18 for EUR/USD, compared with 1.14 currently. That is not to suggest a standout euro but more so a view that the broad dollar should moderate as Fed repricing matures and second-half depreciation resumes."

"The inflation backdrop is also less supportive than it appeared a month ago. Headline inflation spiked in the spring, but the latest figures suggest the worst may be behind us, assuming oil prices do not reaccelerate. Core inflation has also eased, leaving inflation above target but not obviously sticky enough to force a more aggressive sequence of ECB rate hikes."