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The Week Ahead – ECB has little choice but to tighten faster

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EURUSD falls over gloomy outlook

The euro weakens as traders fret that an aggressive ECB is pushing the bloc to the brink of a recession. Euro zone inflation continues to surge and could hit a double digit soon. Prices excluding volatile food and fuel jumped over 5%, which is a sign that inflation is gaining a foothold across the economy, and cementing expectations of a 50 to a 75bp hike by the ECB at the upcoming meeting. Despite the risk of an economic slowdown, the central bank might count on deflation to put the brakes on consumer price growth. The pair is struggling to defend parity and may head towards 0.9700. 1.0350 remains a tough hurdle.

AUDUSD retreats over cautious mood

The Australian dollar falls back as risk appetite takes a backseat. Upbeat retail sales and business investment may encourage the RBA to lift interest rates for a fifth straight month. Another 50 basis points are likely to be on the table this week. However, currencies move in relative terms, and the US Fed’s hawkish stance could overshadow the Antipodean. Markets have switched to a risk-off mode once again and would weigh on growth sensitive assets. China’s predicaments from Covid lockdowns, heat waves and a real estate crisis add another layer of risk to the aussie proxy. 0.6700 is a critical floor and 0.7000 a fresh resistance.

USDCAD rallies on growth divergence

The Canadian dollar retreats over a downbeat economic outlook. Canada’s GDP growth fell short of expectations in the second quarter. The cooling is unlikely to sway the central bank from its normalisation path. Even though inflation eased from its peak in June, it is still well above the BoC’s 2% target. Traders are wagering a 75bp increase this week but it may not be enough to support the loonie in a flight-to-quality environment. While demand for the greenback picks up again, falling oil prices may pull the rug out from under the commodity-linked loonie. The US dollar is testing 1.3200 with 1.2900 as a fresh support.

SPX 500 retreats as Fed to stay committed

The S&P 500 struggles over the prospect of more restrictive monetary policy. Fed Chair Jerome Powell’s insistence on raising interest rates as high as needed has poured cold water on those betting on a dovish autumn. Even though policymakers acknowledged that it would be a hard pill to swallow for households and businesses, they are relying on a strong labour market to cushion the impact from tighter financial conditions. The index may lose ground as traders price in another 75bp hike in September and exits from wrongfooted buyers could exacerbate volatility. The price is testing 3900 and 4200 is the closest resistance.

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