Weekly Gold Review: Euro Soars, Gold Price Avoids Three-Day Decline, ECB's Hawkish Stance Overshadows FED

This week, the Federal Reserve and the European Central Bank (ECB) both announced new monetary policies. The interest rate decisions were unsurprising—the Fed held steady, while the ECB raised rates by 25 basis points. The Fed maintained its interest rate, with its policy statement and dot plot showing a clear hawkish stance: it is expected to raise rates slightly twice more this year, possibly even in July. The dollar briefly rebounded.

However, the ECB showed a more hawkish tone than the Fed, virtually guaranteeing another rate hike next month, determined to tackle high inflation. The euro surged, putting pressure on the dollar and indirectly benefiting gold. Gold prices rebounded sharply from a new low of $1924.73 per ounce since mid-March, and are poised to rise for the third consecutive week. With further weakening of US economic activity and inflation data, gold is expected to be difficult to fall in the future.

As of press time, spot gold is up 0.24% to $1965.05 per ounce; the dollar index is down 1.33% to 102.165; and the euro is up 1.89% against the dollar to 1.0952.

Fed's hawkish stance temporarily subsides

The Federal Reserve's policy meeting this week kept interest rates unchanged as expected, but surprisingly, policymakers expect to raise rates slightly twice more before the end of the year. Borrowing costs could rise by as much as 50 basis points by the end of the year to address the still-strong economy and the slowing decline in inflation. Fed Chair Powell further predicted at the post-meeting press conference that the July FOMC meeting "may have action," possibly raising rates again.

While raising rate expectations, policymakers also raised their forecast for US economic growth in 2023 from 0.4% to 1% and lowered their forecast for the unemployment rate at the end of the year from 4.5% to 4.1%, thus expecting slower progress in bringing inflation back to the 2% target.

Thus, although the Fed kept interest rates unchanged, the policy statement and dot plot clearly leaned hawkish. Current money market pricing shows a nearly 70% probability of a 25 basis point rate hike in July and a first rate cut in March next year. Bank of America Global Research expects two more 25 basis point rate hikes this year, raising its terminal rate forecast to 5.5% to 5.75%.

Edward Meir, a metals analyst at Marex, said: "Gold's rise has been difficult because the Fed's stance on inflation and interest rates remains strong. Therefore, this has somewhat eliminated the upward momentum of gold, as the Fed is about to raise rates further." Meir added that gold prices may trade in the $1931-2000 range over the next two weeks, with strong resistance at the upper end.

The Fed's hawkish tilt initially boosted the dollar, reversing its early-week decline, but the rally quickly reversed and hit a one-month low as the ECB's hawkish stance and US data showing slowing economic activity and cooling inflation challenged the Fed's hawkish stance.

Shaun Osborne, chief FX strategist at Scotiabank, said: "The risks seem to be skewed towards further downside for the (dollar)...Based on the two-year spread with major currencies, the (dollar index) valuation looks more or less fair. Beyond the near-term interest rate outlook, the dollar may face a more challenging environment. The global monetary policy cycle is nearing its end. We have assumed for some time that the peak of the rate cycle will be a negative factor for the dollar peak, yields will enhance risk appetite, and encourage investors to move capital away from the dollar."

ECB determined to fight inflation to the end

The European Central Bank raised interest rates for the eighth time this week, raising its policy rate to 3.5%, a 22-year high, and said that persistent high inflation rates virtually guarantee another rate hike next month, and possibly further action after that. The euro surged 1.9% against the dollar, hitting a high of 1.0961 during the session, its highest since May 11.

Although inflation has been slowing due to falling energy prices and the ECB's continued rate hikes, the bank has raised its forecasts for core inflation for both this year and next. The experience of severely misjudging the persistence of inflation at the beginning of last year has made it cautious about the slowing momentum of inflation.

Unlike the Fed, however, the ECB slightly lowered its economic growth forecast for this year. However, this does not seem to affect its interest rate hike outlook. Policymakers believe that it is better to tighten policy too much than too little, as premature cessation of action means that contractionary policy must be maintained for a longer period.

Analysts at DZ Bank wrote in a research report: "Our baseline forecast is for a final 25 basis point rate hike in July, with a terminal rate of 3.75%. There were some hawkish elements in the latest ECB press conference, particularly the upward revision of the 2025 inflation forecast. There were also some dovish factors, with Lagarde explicitly stating that there would be a rate hike in July, but deliberately avoiding providing guidance on expectations for September."

Kit Juckes, chief global FX strategist at Societe Generale, wrote: The ECB (taking hawkish measures) prevented the euro's rally from completely disappearing, but a real improvement in the European growth outlook is needed for EUR/USD to break through to the peak of 1.15 to 1.20 that we forecast for the end of 2023 or early 2024. In the coming weeks, signs of improvement in European data will have a greater impact on the euro outlook than the ECB's hawkish rhetoric.

Commerzbank economists said that the probability of the Fed raising rates again in July is high, so there are still some potential surprises, which may temporarily support the dollar. However, as our economists predict that the Fed will cut rates next year, the euro could eventually rise against the dollar.

US data generally weakens

US inflation data released this week showed that the annual rate of CPI in May was 4%, down for the 11th consecutive time and a new low since March 2021, compared to an expected value of 4.10% and a previous value of 4.90%; the annual rate of core CPI in May was 5.30%, in line with expectations and 0.2 percentage points lower than the previous value. The annual rate of PPI in May was 1.1%, down for the 11th consecutive time and a new low since December 2020; the core PPI annual rate was 2.8%, a new low since February 2021.

This is clearly consistent with the downward pressure on commodity prices, although service inflation may prove more sticky. Clearly, the Fed needs to see more evidence that inflation is feeding into consumer prices before it changes its mind, but this is a good start for those who tend to see future yields falling rather than rising.

In addition, the number of initial jobless claims in the US for the week ended June 10 totaled 262,000, the second consecutive week above expectations and previous values after 261,000 (revised to 262,000) the previous week. US industrial production unexpectedly fell 0.2% in May after a 0.5% increase in April. The market had previously expected a 0.1% increase. Although retail sales in May were slightly higher than expected.

Mitsubishi UFJ Financial Group (MUFG) economists say the Fed's policy update hasn't significantly altered their view that the Fed is nearing the end of its rate-hiking cycle. While the Fed may now make one last rate hike in July, they still don't believe a second rate hike is necessary and expect weak activity and inflation data to encourage the Fed to signal sufficient tightening at the Jackson Hole symposium in the summer and/or the September FOMC meeting.

With the weakening of the dollar, gold prices have begun to rebound from strong support levels and have begun to show signs of this anticipated behavior. Historically, gold has served as a safe haven for investors during times of economic uncertainty, including periods of dollar weakness. As investors anticipate a potential weakening of the dollar, gold is becoming an increasingly attractive investment option.