Stéfane Marion and Kyle Dahms of National Bank Canada (NBC) note that the euro has weakened alongside the broader dollar rally, even as euro zone inflation has picked up again and pushed the ECB towards a more hawkish stance. They see EUR/USD mainly as a dollar story, targeting year-end 1.19 from the current level of 1.16, with restricted upside unless eurozone economic growth and exchange rate differentials move more decisively against the dollar.

The euro’s prospects depend on the USD’s path

“The euro softened alongside broader USD growth, even as euro zone inflation became more challenging for the ECB. Headline inflation rose to 3.2% y/y in May, while core inflation rose to 2.5%, leaving both measures uncomfortably above target and pointing to a more persistent inflation problem than policymakers would like.”

“We therefore view the path of the euro mainly as a USD-related situation. Our year-end target is 1.19 for EUR/USD compared to the current level of 1.16. This is not a strong call for euro exceptionalism.”

“The view is that the broad dollar is expected to weaken as the Fed’s repricing matures and the second-half depreciation trend returns. The single currency may participate in this move, but growth is likely to be gradual unless economic growth improves more convincingly or short-term spreads turn more decisively against the dollar.”

“For the euro, however, the issue remains relative. A more hawkish ECB could help limit the decline in the euro, particularly if markets continue to price in some risk of renewed policy tightening. However, this alone will not be enough to generate sustained growth if the Fed also rerates in a more hawkish direction.”

“In this sense, the short-term resilience of the euro should remain, but the case for a move towards our year-end target of 1.19 still depends largely on the broader USD weakening we expect in the second half.”

(This article was created with the facilitate of an artificial intelligence tool and has been reviewed by an editor.)