ECB will hold a meeting today. Market participants are primarily concerned about the ECB’s reaction function to upside inflation risks, as well as how the European regulator perceives the prospects for “second-round” of inflation effects. This will determine the demand for European assets and, accordingly, the euro.

Central banks around the world are gradually moving towards tightening monetary policy in response to rising prices and the associated rise in inflationary expectations of investors and households. The European Central Bank is considered one of the least inclined to rush to cut stimulus, but it should be borne in mind that inflation in the Eurozone accelerated to 3.4% (maximum since 2007), and the pace of asset purchases continues to remain at levels close to the levels of 2020, when the economy was experiencing deep recession.

The Minutes of the September meeting of the ECB showed that the Governing Council discussed gradual slowdown in the pace of asset purchases under the PEPP program. Therefore, investors should be interested in how quickly the ECB will move to raise rates. This will depend on how worried the ECB is that the inflation shock, triggered primarily by supply disruptions, will translate into wage inflation, as an income shock could trigger another round of inflationary effects that could keep inflation elevated next year. In this case, it will harm recovery. That is why the yield curve in some developed countries begins to gradually flatten – long interest rates rise relatively to short interest rates, that is, the shift in demand happens from short-term debt instruments to the ones with longer-maturity. This may mean that expectations of stagflation are gradually beginning to emerge in the market – expectations of a period with low rate of real output and high rate of inflation.

In the past few days, EURUSD has been in consolidation, fluctuating in the range of 1.158-1.1620. There is a risk that the ECB will disappoint investors today, pointing out a more modest pace of exit from the anti-crisis policy, which, in the face of price pressures, may trigger a search for yield elsewhere. In this case, the demand for the euro may suffer and the EURUSD rate may test the lower border of the downtrend at around 1.1520 and below: