Euro Surges Above 1.09 as German Inflation Heats Up

The euro gained ground against the U.S. dollar on Thursday, breaking above the key 1.09 level and challenging this month’s high. The rally was driven by a combination of factors, including upbeat risk sentiment, a weaker greenback, and stronger-than-expected inflation data from Germany.

The main catalyst for the euro’s rise was the release of the German consumer price index (CPI) for March, which showed a faster increase in the cost of living than anticipated. The CPI rose by 0.8% month-on-month and 7.4% year-on-year, beating the consensus estimates of 0.7% and 7.3%, respectively.

The higher inflation rate in Germany, the largest economy in the eurozone, suggests that price pressures are building up in the region and may force the European Central Bank (ECB) to tighten its monetary policy more aggressively. The ECB has already hiked its benchmark interest rate twice this year, from -0.5% to -0.3%, and is expected to deliver more rate hikes in the coming months.

Monetary Policy Divergence Favors Euro

The euro’s strength was also supported by the contrast between the ECB’s hawkish stance and the Federal Reserve’s dovish one. The Fed has kept its policy rate unchanged at near zero since March 2020, despite rising inflation and robust economic growth in the U.S. The Fed has also maintained its massive bond-buying program at $120 billion per month, signaling that it is not in a hurry to taper its stimulus.

The Fed’s cautious approach reflects its concern about the stability of the U.S. banking sector, which has been hit by a series of scandals and losses in recent months. The most notable case was the collapse of Archegos Capital Management, a family office that defaulted on margin calls from several major banks, causing billions of dollars in losses.

The divergence in monetary policy between the ECB and the Fed is likely to provide a tailwind for the euro against the U.S. dollar in the near term. However, other factors may limit the upside potential for the common currency, such as the slow pace of vaccination in Europe, the political uncertainty in Germany ahead of the September elections, and the potential for trade tensions with the U.S. over digital taxes and steel tariffs.