Nordea's strategists Sara Midtgaard and Henrik Unell see scope for Euro (EUR) appreciation against the US Dollar (USD) as policy divergence grows. They expect the European Central Bank (ECB) to deliver more rate hikes than currently priced, while the Federal Reserve (Fed) remains on hold even if United States (US) inflation accelerates. In a scenario where Europe tightens and the US does not, Nordea argues the Euro could strengthen and the Dollar weaken.

ECB hikes versus static Fed underpin Euro

"A key driver behind the dollar’s appreciation in May has been the repricing of Fed expectations. Markets have moved from assigning some probability to rate cuts towards pricing in additional tightening. Our baseline case, however, remains that the Fed will keep rates unchanged over the next two years."

"At the same time, we expect the ECB to deliver a total of four rate hikes this year, compared with the roughly three hikes currently priced in by markets."

"Over time, market focus may shift if inflation in the US continues to accelerate without a corresponding response from the Federal Reserve."

"The growing divisions within the Fed could make the central bank less decisive in responding to higher inflation pressures, precisely because policymakers appear increasingly split between those who still view the next appropriate move as a rate cut and those who believe further hikes may eventually become necessary."

"However, this relationship may prove less straightforward if higher inflation in both the US and the euro area results in tighter monetary policy in Europe but not in the US."

"In such a scenario, the euro could strengthen and the dollar weaken."

(This article was created with the help of an Artificial Intelligence tool and reviewed by an editor.)