EUR supported by yield spreads & optimism over Ukraine peace deal

EUR: ECB-Fed policy divergence & progress on Ukraine peace deal in focus

The euro has continued to strengthen gradually against the US dollar lifting EUR/USD to an intra-day high of 1.1653 overnight. After hitting a low of 1.1491 on 21st November, the pair has closed higher for seven consecutive days. It is currently attempting to close above resistance from the 55-day moving average at around 1.1625 for the first time since mid-October. EUR/USD has been lifted over the past seven trading days by the dovish repricing of Fed rate cut expectations. The US rate market has moved to almost fully price in a third consecutive 25bps rate cut from the Fed this month weighing on the US dollar’s performance more broadly. At the time, market participants have become more convinced that the ECB’s rate cut cycle has come to an end. The 2-year euro-zone government bond yield has risen up to its highest level at the start of this week since back in March prior to the negative shock from President Trump’s “Liberation Day” tariffs announcement in early April.

Market expectations for the ECB to leave rates on hold going forward were encouraged yesterday by the release of the stronger than expected euro-zone CPI report for November. The report revealed that headline inflation picked up by 0.1 point to 2.2% in November. The pick-up in headline inflation was driven by the energy component while core inflation remained unchanged at 2.4%. However, the details of the report also revealed a pick-up in services inflation to 3.5% up from 3.4% in October. It was the strongest services inflation print since April 2025 adding to evidence that disinflation in the services sector has stalled since the summer. The report casts some doubt on whether inflation will continue to slow as we expect in the year ahead, and undershoot the ECB’s target. Back in September, the ECB was expecting headline and core inflation of 2.0% and 2.2% in Q4. Recent data point to a slightly higher starting point for the next update of the ECB staff projections. Firmer inflation and stronger than expected growth in Q3 when real GDP expanded by 0.2% should make the ECB more confident policy is currently in the right place. We are still holding on to our call for one final 25bps ECB rate cut next year encouraged by inflation undershooting its target, but acknowledge the building risk that the low point for ECB rates may already be in place. Nevertheless, we expect the Fed to be more active in cutting rates going forward compared to the ECB supporting our forecasts for EUR/USD to move above the 1.2000-level in 2026.

The recent strengthening of the euro may also reflect cautious optimism over the potential for a peace deal to bring an end to the conflict in Ukraine. The Kremlin stated that it held “very useful” talks with US envoys Steve Witkoff and Jared Kushner yesterday although the sides failed to reach an agreement on a plan to end Russia’s war in Ukraine. The negotiations lasting five hours were described as “constructive and very informative”, though “compromise hasn’t been reached yet” on the critical issue of territorial control according to Kremlin foreign policy aide Yuri Ushakov. He did add that “some American proposals seem more or less acceptable, but they need to be discussed. Some of the wording we’ve been offered isn’t acceptable, so the work will continue”. A possible meeting between Presidents Putin and Trump “will depend on what progress is being made”. It was also been reported that Ukraine’s delegation is ready to meet with US counterparts soon if the talks yield results. It follows criticism from President Putin earlier in the day that European leaders were attempting to sabotage peace efforts with “unacceptable” changes to the proposals. While it is still too early to conclude that a peace deal will be reached, recent progress in talks has increased the likelihood of the conflicting ending in 2026. A development that if realized would be supportive for the euro and other European currencies. The negative energy price shock for Europe’s economy is continuing to ease with the price of natural gas falling to fresh year to date lows heading into year end, and currently stands just over 40% lower that at the same time of last year.                    

EUR/USD LIFTED BY NARROWING YIELD SPREADS

Source: Bloomberg, Macrobond & MUFG GMR

AUD: Hawkish RBA comments offset impact from weaker GDP report

The main economic data release overnight was the latest GDP report from Australia, which revealed the economy expanded less than expected by 0.4% in Q3. It was partially offset by a 0.1 point upward revision to growth in Q2 up to 0.7%. It has helped to lift the annual rate of growth back up to around 2% in recent quarters. The RBA had been expecting growth of 0.5% in Q3. The breakdown revealed that household spending added 0.3 ppts to growth and government spending added 0.3ppts, while the biggest drag on growth were inventories subtracting -0.5ppts. However, the softer GDP report has not discouraged the recent hawkish repricing of RBA rate expectations. The Australian rate market has moved to almost fully price in a rate hike from the RBA in light of the tighter than expected labour market conditions and the pick-up in inflation pressures. Those expectations were encouraged overnight by comments from RBA Governor Bullock who stated that the labour market is “a little tight”, and the output gap has “probably closed”. She then signalled that persistent inflation will affect the future policy path. Finally, she emphasized that the RBA is “alert to the possibility CPI pressures might be building”, and “if CPI pressures build, the board will respond accordingly”. A development that would encourage a stronger Australian dollar.

KEY RELEASES AND EVENTS

Source: Bloomberg & Investing.com