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Interest rate cut expected at June 6 ECB meeting

Euro firms slightly ahead of ECB meeting, rate cut expected

The euro firmed slightly on Thursday ahead of the European Central Bank (ECB) policy decision, with traders almost certain of a rate cut, while the dollar eased due to renewed bets on a U.S. Federal Reserve easing cycle expected later this this year.

The Canadian dollar edged up slightly, recovering some losses from the previous session after the Bank of Canada became the first G7 country to cut its key policy interest rate, as widely anticipated by markets. The “loonie”, as the Canadian dollar is widely referred to in forex markets, was last trading at C$1.3679 per dollar.

The euro rose 0.17% to $1.0887, as traders awaited the ECB meeting later in the day for guidance on the central bank's interest rate outlook. Policymakers have signaled an intention to lower borrowing costs this month but have remained cautious about the timing of further cuts.

Market strategist Henk Potts at Barclays Private Bank commented on the upcoming ECB meeting to Reuters:

"The Governing Council's rationale will likely be driven by a stronger-than-expected recovery in (business) activity and increased confidence that inflation will return to the targeted level. Beyond the June meeting, we forecast that we could see quarter-point cuts in September and December”.

The ECB’s inflation target is 2% over the medium term. The latest Eurozone inflation figure saw the currency bloc’s consumer price index rise by 2.6% year-on-year in May after 2.4% increases in the previous two months, as per a flash estimate from Eurostat.

Despite the larger-than-expected inflation increase, the ECB is still anticipated to lower borrowing costs. In his morning note on June 5, Markets.com Chief Market Analyst Neil Wilson gave an overview of the market’s view of a likely impending rate cut at Thursday’s ECB meeting:

“The market is fully pricing a rate cut, which would be the first since 2019. Policymakers have been pretty vocal in saying June is ‘on’.

In a recent interview, ECB chief economist Philip Lane said that ‘at this point in time there is enough in what we see to remove the top level of restriction’. You don’t get much clearer a signal than that in central bank speak, and there has been plenty of others basically saying June will see a cut”.

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Dollar on the defensive as U.S. labor market eases

In the broader market, the U.S. dollar was on the defensive, pressured by easing labor market conditions in the United States, which strengthened the case for Fed rate cuts this year. Markets have priced in nearly 50 basis points of Fed rate cuts in 2023, with the first expected in September.

A note from economists at Wells Fargo cited by Reuters read:

"While new orders suggest continued demand, the selected industry comments and continued employment contraction reveal a touch of caution among service providers”.

Data on Wednesday showed the U.S. services sector returned to growth in May after a brief contraction in the previous month, though employment within the sector remained in contraction territory.

Against the U.S. dollar, the New Zealand dollar touched a three-month high of $0.6215, while the British pound rose 0.05% to $1.2795, and the Australian dollar edged 0.21% higher to $0.66615.

The U.S. dollar index (DXY) fell 0.11% to 104.14.

Euro firms ahead of ECB meeting on June 6

Japanese yen perks up as carry trades unwind, BoJ expected to scale back bond buying

Elsewhere, the Japanese yen was broadly firmer on the day, rising 0.2% to 155.78 per U.S. dollar.

Earlier this week, the Japanese currency saw a brief rally as investors unwound yen-funded carry trades following a strong election victory for Mexico's ruling party, which raised concerns about disputed constitutional reforms.

This led to a squeeze on long peso/short yen positions, a favored strategy among carry traders. In carry trades, investors borrow in a low-interest currency and invest in a higher-yielding one.

The Mexican peso was last up 0.2% against the yen, adding to its 2.6% gain from the previous session. It had dropped about 6% against the yen earlier in the week after Mexico's election results.

The yen slipped slightly against the euro, with the common currency gaining close to 0.2% on the day ahead of the ECB meeting. As of 08:30 on June 6, the EUR to JPY pair traded around the 170 mark. The yen has shed almost 9.2% of its value against the euro so far this year.

Contributing to the yen's gains were expectations that the Bank of Japan (BoJ) might scale back its massive bond purchases as early as this month sa it moves towards an exit from massive monetary stimulus.

BoJ Governor Kazuo Ueda indicated on Thursday that reducing the central bank's bond buying would be appropriate as it moves toward exiting its extensive monetary stimulus. His remarks come ahead of the BoJ's two-day monetary policy meeting next week.


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