Euro / Dollar Week Ahead Forecast: Ukraine Fallout Mounts

Modified: Monday, 07 March 2022 07:46 GMT
Written by: James Skinner

EUR/USD vulnerable as Ukraine fallout mounts
Little to support EUR ahead of 1.08 & 1.0635
But ECB decision could offer short-term relief
If accelerated normalisation remains on table

Image © Adobe Stock

The Euro to Dollar rate entered the new week close to two-year lows and may be susceptible to further losses ahead of this Thursday’s European Central Bank (ECB) monetary policy decision, which could potentially have a stabilising influence on the single currency at the tailend of the week.

Europe’s single currency booked its largest one week decline since March 2020 when the coronavirus first closed down the global economy last Friday after an escalating and increasingly destructive conflict in Ukraine weighed heavily on currencies across the continent as well as further afield.

But with the Ukrainian government anticipating an escalation of the artillery and air assault on the capital as soon as Monday, the risk is of the Euro remaining under pressure against the Dollar and many other major currencies over the opening half of the week.

“The EUR has broken under 1.10 to now face limited support markers until psychological floors in the 1.09 and 1.08 zones. However, the currency’s move into oversold conditions on the RSI suggests the move to these levels is unlikely to occur in quick succession,” says Juan Manuel Herrera, a strategist at Scotiabank.

There is some chance, however, that this Thursday’s economic forecasts and monetary policy guidance from the ECB will have Euro-supportive implications given the financial and economic side effects of the conflict in Ukraine and resulting humanitarian crisis are highly inflationary.

Above: Euro to Dollar rate shown at weekly intervals with Fibonacci retracements of 2020 recovery indicating possible areas of technical support, and shown alongside Polish Zloty Vs U.S. Dollar exchange rate.

EUR/USD reference rates at publication:
Spot: 1.0872
High street bank rates (indicative band): 1.0450-1.0568
Payment specialist rates (indicative band): 1.0774-1.0818
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Crude oil prices have surged far above $100 per barrel and were nearing financial crisis highs on Monday while natural gas prices had reached new records due in part to market concerns about a possible loss of supply from Russia, and each of these developments will lift inflation further above the new record highs already reached in February and reported just last week by Eurostat.

“The ECB will weigh up the risk of higher inflation with weaker economic growth. We consider the risk is the ECB plays down the negatives on economic growth, supporting EUR intraday,” says Joseph Capurso, head of international economics at Commonwealth Bank of Australia.

Eurostat figures showed Eurozone inflation rising from 5.1% to 5.8% in February, taking it to a new record high and above even the 5.4% seen in the UK, while the more important core measure of inflation increased from 2.3% to 2.7% in another sign that non-energy price pressures had continued to build early in the new year and even before Russia’s invading army crossed the border into Ukraine on February 24.

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This is all potentially significant given that President Lagarde said previously in February’s press conference that inflation risks were already shifting higher and had also declined to reiterate an earlier opinion that Europe’s interest rates would be unlikely to rise this year, in turn leading financial markets to become more confident in betting that an end of the negative interest rate era could be near.

Financial markets have since marked down their expectations for the bank to cease buying European government bonds and lift its deposit rate from -0.5% to 0% this year, although the danger is that the ECB Governing Council concludes the war in Ukraine could further necessitate an accelerated withdrawal of its extraordinary monetary support for the Eurozone economy later this year.

“Even if spillovers damage the Euro Area’s growth prospects we are unsure that it would result in sustained EUR depreciation, because the ECB may also worry about the implications for inflation, and policymakers may respond to the crisis with fiscal easing,” says Zach Pandl, co-head of global foreign exchange strategy at Goldman Sachs.

Above: Euro to Dollar rate shown at daily intervals alongside spread, or gap, between yields on 02-year German government bond yields and U.S. government bond yields.

“Moreover, if Euro Area growth holds up reasonably well and the ECB remains on track to raise rates this year, we would still see a bullish structural outlook for the currency. For now we stay on the sidelines in EUR crosses while we await more clarity on the unfolding geopolitical crisis,” Pandl and colleagues wrote in a Friday research briefing.

Should the ECB indicate on Thursday that its symmetric two percent inflation target is likely be met sustainably over the medium-term without any further need for “the accommodative impact of policy rates to be reinforced” by quantitative easing, then it would be a clear signal of continuing scope for it to announce further steps toward normalisation of its policy settings later this year.

That would potentially in turn reignite and reinforce market expectations for an uplift in Eurozone interest rates later in 2022, the first since 2011, although some analysts have warned the Euro could remain vulnerable to further losses in the short-term no matter what the ECB does on Thursday.

“European currency markets are becoming stressed. For example, the bid-offer spread for EUR/USD widened to high levels on Friday. The overall environment for EUR will remain negative in the short term. There is a reasonable chance EUR/USD tests the pandemic low of 1.0688 this month given the very poor market sentiment,” CBA’s Capurso and colleagues cautioned on Monday.