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Bank of Canada and ECB hide their fear against stagflation risk. Overview of the currency market

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Good profit and loss reports continue to support US stock markets and generally contribute to the demand for risk, despite weaker-than-expected GDP data for the third quarter.

The Bank of Canada and the ECB held their regular meetings. Despite the different starting conditions, both the ECB and the BoC react the same way on a number of issues. This reaction is an attempt to remain calm before the growing threat of stagflation.

After the markets reacted to the not quite expected outcome of the BoC meeting, it turned out that the /exchange rate slightly changed, finding no reason to leave the consolidation zone. At the same time, T-bills yields increased quite a bit – 2-year bonds added about 25p, while 10-year bonds added around 50p. They were above current levels a week ago. This dynamic means that the results of the meeting were generally in line with market expectations, and now the main question is, what’s next?

So what did BoC do? The Bank of Canada has completed quantitative easing and started the reinvestment phase of its quantitative easing program. It should be noted that reinvestment starts on November 1 and will include the distribution of about $ 4-5 billion monthly between the primary and secondary markets, which will keep the size of the Canadian Government’s bond portfolio in current volumes and postpone the forecast for an interest rate increase. The rate is now expected to be raised sometime between April and September when inflation will normalize at the 2% target.

The Bank of Canada ended the QE program ahead of schedule due to pressure from circumstances, primarily due to much higher inflation forecasts. Now, it expects that the “temporary nature” of inflation will be stopped by the measures taken.

For the Canadian dollar, the situation has not become more bearish or more bullish. A faster exit from QE may be perceived by the markets as a sign of the hawkish position of the BoC and provoke an increase in demand for CAD, but, on the other hand, the Bank shifted the forecast for the rate to a later date than it stopped the bullish mood. In total, nothing seems to be changing yet. The USD/CAD exchange rate is expected to remain in the consolidation zone with some bearish bias. The targets are 1.2284 and 1.2250, which means that there are no changes.

The ECB meeting ended without any new decisions, but the markets reacted with an increase in demand for the euro, considering that the ECB’s position had shifted to the hawkish side. As ECB President Lagarde said at the final press conference, the Central Bank discussed 3 things at the meeting. She identified 3 factors that stimulate inflation – rising energy prices, mismatch of supply and demand, and basic effects (for example, VAT in Germany). Regarding the threat of stagflation, Lagarde said that if there is inflation, there is no stagnation, although she acknowledged that there is a threat of a slowdown in growth in the eurozone.

As for the “temporary” nature of inflation, it is still possible to accept the ECB’s arguments, but it should be borne in mind that inflation expectations remain high and there are no signs of a decline.

The EUR/USD rate surged by almost a figure after the meeting, and this is a natural reaction since the temporary nature of inflation is in great doubt. Energy prices remain consistently high, and even if Gazprom begins to increase the occupancy of its European storage facilities following the president’s order, this may not have a positive effect, since buyers are not in a rush to conclude new purchase contracts at current prices. High energy prices will lead to an increase in the cost of production, which threatens to reduce the utilization of production capacities. And this means an increase in the threat of stagflation.

It is clearly early to assume that the growth of EUR/USD means a bullish reversal. It can be said that a return to sales is likely after a short consolidation in the range of 1.1660/1710 range, so the target of 1.15 remains relevant.

*The market analysis posted here is meant to increase your awareness, but not to give instructions to make a trade.

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