Euro Climbs on Hawkish Comments from ECB Smaghi

The EUR/USD continued to extend its laborious climb upward in this week's trading. Overnight, the pair slid, giving back yesterday's gain, as we had China boosting its bank reserve ratio requirement yet again in its battle against inflation and concern remain about Portugal being pressured to take a bailout.

However, as we entered the NY session, hawkish comments from ECB Executive Board Member Lorenzo Bini Smaghi helped the EUR/USD to rebound and rally to a fresh high this week at 1.6445.

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Here's the comments that got the most attention, via Bloomberg:

As the economy gradually recovers and global inflationary pressures arise, the degree of accommodation of monetary policy has to be monitored and, if needed, corrected, Bini Smaghi said in an interview with daily newsletter Bloomberg Brief: Economics. Commodity-price increases will have an unavoidable impact and it is a key challenge for monetary policy to avoid spillovers and maintain inflation expectations in check, he said. This requires the ability to take pre-emptive actions if needed.

Expectations Around Interest Rates Favor GBP, EUR over USD

Overall the pecking order is putting the Fed in last place in terms of interest rate expectations. The GBP has jumped out to a lead because of the BoE has shifted its upside risk for inflation to the top side. The annual CPI is already running at 4% rate and we have seen several members voting for interest rate increases. A move may come as early as May, which is much sooner that projects 2 months ago.

The ECB is second after the BoE as it too has had inflation move above its 2% target level (2.5% y/y in January) and that has made the ECB turn up its rhetoric on inflation. Here too a rate hike, which was penciled in for late 2011 if not 2012, can be moved up to early in the 4th quarter. Again, expectations are still uncertain right now and that is causing a good amount of back and forth action in the majors.

Still, its the USD and the Fed bringing up the rear in terms of expected interest rate increases. The expectation is for no move until 2012. And there are still some corners calling for more quantitative easing, though right now steady as you go is the approach of the Fed. Inflation is not as big a problem in the US, in that underlying core CPI is running at 1%. The headline annual rate moved up to 1.6% for January.