EUR/USD Holds Near Two-Week High Ahead of ECB Decision

EUR/USD is trading near a two-week high as investors await the European Central Bank's (ECB) monetary policy decision. Markets widely expect a 25-basis-point rate hike to 2.50%, but the bigger directional catalyst for EUR/USD will come from ECB President Christine Lagarde's guidance on further tightening.

The energy shock has changed the ECB's rate outlook, with Brent crude above US$100 per barrel and Eurozone inflation above 3%. This creates an uncomfortable policy mix for the ECB as higher oil and gas prices lift inflation while threatening economic growth.

A Reuters poll shows economists broadly expecting today's 25-basis-point hike to 2.50%, but with most forecasting that this would be the final increase in the current cycle. However, Deutsche Bank now expects another 25-basis-point ECB hike in December, taking the potential terminal deposit rate to 2.75%.

The balance of risks has shifted toward a more hawkish stance as the Middle East conflict intensifies. A hawkish ECB combined with stable Fed expectations would favor EUR/USD, while indications that the ECB is near its terminal rate alongside rising Fed hike expectations would strengthen the US dollar.