The EUR/USD exchange rate continues to rise despite improvements in core inflation dynamics

One of the most important economic data from the Eurozone was released this week. On Wednesday The final CPI y/y data showed inflation of 6.9% in the Euro area.

Luxembourg and Spain recorded smaller increases with 2.9% and 3.1% respectively. While the eurozone average of 6.9% is well above the European Central Bank’s (ECB) target of 2%, it remains well below inflation levels in the rest of the world. For example, inflation in the United Kingdom is in the double digits.

In other words, it depends on what one wants to read from this week’s data. Of course, prices of goods and services in the euro area rose faster than the ECB expected.

But some positive signs are worth noting.

Average and core inflation eased in March

Central banks, including the ECB, prefer to consider measures of inflation excluding volatile prices of food and energy. Therefore, core inflation data exerts more influence on policymakers in setting interest rates.

If core inflation holds steady over the summer, the ECB will likely stick with rate hikes of 25 basis points instead of 50 basis points.

But why this bullishness in the EUR/USD rate if the ECB is going to raise less than ever due to an improvement in core inflation?

The response has been coming from across the Atlantic as the central bank embraces a small recession.

Economic indicators point to an economic slowdown in the US

The call for a higher EUR/USD exchange rate is based on possible immediate differences between the central bank and the ECB. So far, the central bank has raised funds rates faster than the ECB.

However, economic indicators have recently shown that an economic recession could hit the US. If so, the central bank will pause or taper, but the ECB will not.

For example, the leading economic index has predicted every recession since 1965. It’s currently in recession – why should it be any different this time? New manufacturing orders have also hit alarming lows.

The Fed has $300 billion on its balance sheet to support troubled banks. Additionally, tech companies continue to lay off, which is never good for the US economy.

While improvements in the euro area’s key inflation data could lead to a small increase in the ECB’s policy rate, the gap with the central bank threatens to narrow. A higher EUR/USD rate would make sense under such assumptions.