Should you buy or sell the euro amid regaining the 1.02 level against the US dollar?

Two days before the European Central Bank (ECB) meeting, the common currency, the euro, is increasing. After briefly trading below parity last week, dropping into the 0.9950 area against the US dollar, the euro bounced strongly and gained across the board.

As such, the EUR/USD regained the 1.02 level, the EUR/JPY moved above 150 again, and other euro crosses are bid too.

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Responsible for the move higher is the ECB. Rumors in the market that the central bank is willing to discuss a 50bp rate hike at this week’s meeting have lifted the common currency.

Except for the Bank of Japan, the ECB is the last major central bank to raise the rates. Persistently higher inflation combined with a weaker currency made the ECB’s job difficult, and the central bank wants to ensure the market participants still believe that the euro is an anchor to price stability.

So now that the common currency bounced from its recent lows is it time to buy or sell it? After the ECB meeting, will we see a “buy the rumor sell the fact” reaction?

It all depends on what the ECB will do and say. Therefore, let’s have a look at two scenarios, one dovish and one hawkish, and how the common currency might react.

A dovish ECB scenario to send the EUR/USD back below parity

Believe it or not, a dovish ECB scenario implies the central bank delivers the first rate hike in years. But if it does so by hiking the rates by only 25bp, the market participants will see it as a dovish outcome.

Money markets are now implying a 100bp rate hike from the ECB until September, meaning a 50bp rate hike this week,  followed by another similar one in September. Therefore, if the central bank delivers a smaller rate hike, that would be viewed as a dovish outcome and the EUR/USD might fall again below parity.

A hawkish ECB might trigger a further short squeeze in the common currency

One of the problems at hand for the ECB is a weak currency in the context of rising inflation. The combination of the two undermines the trust in the central bank’s ability to fulfill its price stability mandate.

As such, the ECB may decide to surprise markets by delivering a very hawkish message this week. Under such a scenario, the central bank may hike the interest rate by 50bp on Thursday and vow to raise it by another 75bp in September.

In this case, the common currency might squeeze higher some more, with 1.05 and 145 as possible short-term targets for the EUR/USD, respectively the EUR/JPY pairs.