Markets demand tighter ECB monetary conditions

This morning saw the euro hit a fresh yearly high against the dollar even before the Eurozone PMI data was released, but it has since been heading lower. The euro’s recent strength is almost as if market participants are trying to front-run the European Central Bank or telling it what to do. Speculators and certain German officials for that matter.

This morning saw the euro hit a fresh yearly high against the dollar even before the Eurozone PMI data was released, but it has since been heading lower. The euro’s recent strength is almost as if market participants are trying to front-run the European Central Bank or telling it what to do. Speculators and certain German officials for that matter. And who would blame them? After all, sentiment has been improving towards the Eurozone again. This is in part because political uncertainty has receded sharply, especially after the pro-euro and market-friendly outcome of the French election. What's more, economic data has been improving steadily and inflation has been on the rise in the single currency block. Indeed, today’s economic data releases from the Eurozone have been mainly positive. The manufacturing PMI from the single currency bloc, for example, surpassed analysts’ expectations for the ninth consecutive time as it rose to a solid 57.0 reading from 56.7 previously. In Germany, the manufacturing PMI rose to 59.4, apparently its highest level in 73 months. The German Ifo also surprised to the upside, as too did French services PMI.

Thus, given that the ECB's primary mandate is price stability, the central bank cannot ignore the possibility of overcooking inflation, especially as oil prices have also been going higher again.  However, the ECB has so far remained tight-lipped. It hasn’t given any clear indications that it is about to tighten its policy any time soon. But the pressure is growing nonetheless. This is basically what has been the driving force behind the euro rally, as investors believe that the policy disparity between the ECB and other major central banks will begin to tighten. This should make the job of certain central banks easier, most notably the Swiss National Bank. This may help to ease the pressure on the EUR/CHF pair. But against other currencies, the euro could also push further higher, especially those where the central bank is still dovish.

EUR/JPY about to embark on a rally towards 130?

Among the euro pairs, the EUR/JPY is the one which has caught my attention of late. This pair has surged higher in recent times, breaking through several levels of resistance, including 124.10, which was the prior swing high. Mind you, it has had difficulty breaking through this level, but while above it, the short-term bias would have to be bullish. If and when the EUR/JPY establishes a firm footing around the psychologically important 125 handle (where it was trading around at the time of this writing), then it could start to head towards 126.45-60 area initially (127.2% Fibonacci extension and prior high), then possibly 128.15 (old resistance) and followed by 129.80-130.00 area next (projected point D of an AB=CD price pattern). However, all bets would be off in the near-term if price goes back below 122.80 support on a daily closing basis. In fact, the bulls would not want to see the EUR/JPY trade back below that 124.10 hurdle again.  

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