• EUR/USD remains above 1.1420, surprisingly steady amid the deteriorated market sentiment.
• Escalating hostilities in the Middle East and the jump in Oil prices pose significant headwinds for the Euro.
• FX Analysts see the Euro supported by ECB rate-hike expectations.

The Euro (EUR) remains steady above 1.1400 against the US Dollar (USD) on Thursday, showing a surprising resilience to the surging Oil prices and the escalation of hostilities in the Middle East. Analysts from some of the world’s major commercial banks point to bets on European Central Bank (ECB) rate hikes as the main support for the common currency.

In a few hours, the ECB is widely expected to leave its benchmark Rate on the Deposit Facility steady at 2.25%, following a 25 basis points rate hike in June. The cooling inflationary pressures seen earlier this month have provided a valuable margin for the bank to assess further developments, but the sharp recovery in Oil prices has fuelled hopes of further tightening down the road.

MUFG Analysts: Yield spreads move against the USD

Analysts at MUFG note that in response to rising energy prices, market participants have been moving to price in "more hawkish expectations for major central banks including the ECB and Fed, resulting in short-term yields rising to fresh year-to-date highs.”

The MUFG experts observe that “the Eurozone rate market is now pricing in two to three further ECB rate hikes in the year ahead, while the US rate market is pricing in around two Fed hikes over the same period.” In that context, short-term yields “have risen more recently in Europe than in the US, resulting in yield spreads moving against the USD.”

In the same line, Societe Generale’s FX team reports that the EUR/USD: 1.1406 - 1.1436 overnight range remains “cheap relative to 2y spread but conviction is low as Gulf war spreads, oil marches on.”

They warn that “hawkish policy deliberations are outweighed by the growth-sapping effect of higher energy prices and hit to Europe’s terms of trade,” meaning that “a return over 1.1480/1.1510 is still a big ask.” In General terms, however, Societe Generale's analysts affirm that “oil-FX correlations remain relatively muted overall despite the price action in energy of the last two weeks,” underscoring the Euro’s struggle to fully benefit from the recent shift in rate expectations.