Euro surges as record inflation adds pressure on ECB

The euro rose for a third consecutive day on Wednesday, coming off a 20-month low last week, as euro zone inflation rose to a new record last month fuelling bets the European Central Bank could raise interest rates sooner than expected.

At 5.1% in January, price growth is more than twice the ECB’s 2% target.

The euro has slipped almost 8% in three months, dented by expectations that the ECB would be the last major central bank to raise interest rates after it shrugged off inflation for months and argued that temporary factors were behind the rise.

The euro strengthened by 0.45% versus the dollar to $1.13245, touching a nine-day high, as investors assessed the chances that the ECB might signal a faster path for policy tightening at its meeting on Thursday.

Ulrich Leuchtmann, head of foreign exchange, said the money market was now pricing in an ECB rate increase for the last quarter of the year.

In the short term the impact on the euro will depend on what ECB President Christine Lagarde has to say on Thursday, he said.

“Some market participants will expect that the ECB will have to sound hawkish tomorrow,” Leuchtmann added.

Shaun Osborne, chief FX strategist, said the ECB is in an “uncomfortable position”, but he expected it to remain committed to its guidance for no hikes this year, “which will remain a drag on the euro”.

In the meantime, the dollar retreated from a 19-month high reached against a basket of currencies last week, as U.S. Federal Reserve officials cautioned against potentially aggressive rate increases this year.

A chorus of Fed officials said they would raise interest rates in March but spoke cautiously about what might follow, indicating a desire to keep options open given the uncertain inflation outlook.

The dollar fell for a third day against its peers, slipping 0.4% to 95.875, with a rally in global equity markets undoing some of its safe-haven allure.

Sterling rose 0.3% to a 12-day high against the dollar at $1.3571 ahead of a Bank of England policy meeting on Thursday.

Investors have fully priced in an expected increase in the BoE base rate by 25 basis points to 0.5% on Thursday.

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