The euro is trading with a slight upward bias against the US dollar in the Asian session, hovering near 1.1625. While an ECB rate hike is essentially a foregone conclusion, the real uncertainty rests on President Christine Lagarde's guidance regarding the future policy trajectory.
MUFG expects the European Central Bank to deliver its second consecutive 25 basis point rate increase this week, a move that is already fully priced in by the market. Consequently, the direction of the euro and eurozone interest rates will depend more on Lagarde's policy signals than the decision itself. Since the summer, market repricing has shifted notably hawkish—spiking natural gas prices and demonstrated resilience in the eurozone economy have led traders to price in approximately 75 basis points of additional tightening through mid-2026, raising the threshold for a hawkish surprise from the ECB.
With the ECB's rate rise now a certainty, attention turns to Lagarde's press conference guidance, notably after recent data showed the eurozone economy demonstrating relative strength. Second-quarter real GDP grew 0.4% quarter-on-quarter, outperforming some pessimistic forecasts, alongside surging energy prices, which together underpin the case for continued policy normalization. The market's forward pricing now anticipates further tightening, with up to 75 basis points of additional hikes expected into mid-2026, making a hawkish surprise increasingly difficult to achieve.
The subsequent performance of the euro and eurozone rates will hinge heavily on the wording of Lagarde's policy guidance at the post-meeting press conference. MUFG's base case scenario predicts this will be the final hike, raising the deposit rate to 3.00% and formally entering restrictive territory. The bank remains cautiously skeptical about a third increase within the year, citing currently limited evidence of second-round inflation effects and economic fundamentals that do not yet justify a more aggressive tightening path.
If Lagarde fails to explicitly acknowledge the possibility of another hike before year-end, the euro could face modest downward pressure. Additional risks include potential political uncertainty stemming from German state elections and the impact of further winter natural gas price increases on economic and inflation expectations. In the near term, the euro's direction against the dollar is more heavily influenced by factors on the US side, with the currency likely to consolidate within a 1.1600–1.1650 range. Should Lagarde adopt a hawkish stance, confirming a sustained tightening posture, the euro could test the 1.1650–1.1700 zone; conversely, a dovish tone or emphasis on caution might see it retreat toward support around 1.1550. From a medium-term perspective, the euro's trajectory will increasingly depend on the evolution of US-Eurozone interest rate differentials and how European energy price dynamics impact growth and monetary policy, warranting close monitoring of relevant data and policy signals.
JPMorgan points out that the divergence in relative economic growth between the eurozone and the US continues to widen, with the American economy demonstrating greater resilience while European growth momentum remains comparatively subdued. The investment bank notes that a repricing of the Federal Reserve's hawkish stance has pushed real and nominal rate differentials further in favor of the dollar. Following the Iran conflict, the eurozone's terms of trade have deteriorated markedly, energy import costs have risen, and relative equity market returns have also lagged significantly—factors that collectively undermine the euro's appeal. Strategists believe persistently depressed European market sentiment relative to the US will limit the euro's upside. The dollar, meanwhile, benefits from the "American Exceptionalism" narrative and its sustained interest rate advantage, while the euro confronts the twin pressures of weak fundamentals and comparatively passive monetary policy, making a strong reversal unlikely in the near term and suggesting a range-bound, softer consolidation pattern for EUR/USD.
In summary, the ECB's rate hike this week is settled, and focus shifts to Lagarde's guidance. MUFG sees moderate downside risk for the euro should she not endorse another increase this year. Key items to watch include the ECB meeting and Lagarde's remarks, German state election outcomes, and winter natural gas prices. A hawkish Lagarde could spur a euro rebound, while a dovish tone may weigh on the currency. The medium-term path depends on US-Eurozone rate differentials and European energy prices.
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