EUR/USD Weekly Forecast: Euro touches five-month low on growing expectations that ECB will ease before Fed

•  EUR/USD managed to bounce off five-month lows near 1.0600.
• Fed-ECB policy divergence continues to be at the centre of the debate.
• The ECB is expected to cut its interest rates in June.

EUR/USD managed to counter a poor start of the week and reverse course despite the European currency slipping back to the 1.0600 key support against the US Dollar (USD), or five-month lows.

Central banks’ policy divergence remains a key driver

Indeed, investors spent another week predominantly speculating about the timing of the onset of the easing cycle by both the Federal Reserve (Fed) and the European Central Bank (ECB).

Regarding the Fed, the prevailing hawkish remarks from policymakers, coupled with the consistently strong domestic fundamentals, initially indicate that the prospect of a “soft landing” is anything but diminished. In this scenario, and having in mind sticky inflation, the probability of an interest rate cut in the latter part of the year continued to increase significantly.

On the latter, Atlanta Fed President Raphael Bostic predicts US inflation to reach 2% more gradually than previously anticipated, but does not rush to cut rates. New York Fed President John Williams believes the Fed’s decisions are based on positive data and the strength of the economy, adding that there are no predetermined hikes and that if data indicates higher rates, the Fed may adjust accordingly. By the same token, Fed Governor Michelle Bowman argues that efforts to reduce inflation may have hit a wall, leaving uncertainty about interest rates.

Meanwhile, the CME Group’s FedWatch Tool continues to see a rate cut at the September 18 gathering of nearly 65%. Further away, the odds of a rate cut stand at 85% for the December 18 event. Both gauges are significantly higher than readings seen a month ago.

In Europe, ECB’s rate setters accentuated their conviction that a rate cut at some point in the summer (June?) should be appropriate. In fact, the ECB board member Robert Holzmann warned against premature speculation on potential rate cuts in 2024, citing differing inflation dynamics between Europe and the US. The ECB’s Executive Board Member Piero Cipollone expressed expectations for a return to the 2% path next year and achieving the target by mid-2025. If data from June and July confirms this, easing restrictive measures in 2024 may be considered.

In addition, ECB President Christine Lagarde argued this week that the bank intends to lower rates in the near future, unless there are significant unexpected developments. She also suggested that it was premature for the ECB to reconsider its 2% inflation target, as its efforts to control price increases were ongoing. Lagarde noted that inflation in the Eurozone is anticipated to decrease further, and the ECB may reduce interest rates if its longstanding criteria for price growth are met.

All in all, the comparatively muted economic fundamentals in the Euroland against the robustness of the US economy strengthen the anticipation of a stronger Dollar in the near to medium term. This is especially true given the likelihood of the ECB cutting rates before the Fed. In such a situation, EUR/USD is anticipated to experience a more significant decline in the short term.

EUR/USD technical outlook

The breach of the 2024 low of 1.0601 (April 16) may signal a return to the November 2023 low of 1.0516 (November 1), prior to the weekly low of 1.0495 (October 13), the 2023 bottom of 1.0448 (October 3), and the round milestone of 1.0400.

On the upside, EUR/USD is projected to find first resistance at the crucial 200-day Simple Moving Average (SMA) at 1.0817, followed by the April high of 1.0885 (April 9), the March top of 1.0981 (March 8), and the peak of 1.0998 (January 11), all before hitting the psychological barrier of 1.1000. 

Looking at the bigger picture, while below the key 200-day SMA, the downside pressure is expected to prevail.