EUR/USD Week Ahead Forecast: Hawkish ECB Could See 1.10 Tested
- Written by: James Skinner
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- EUR/USD may extend recovery with approach of 1.10 possible
- If Eurozone inflation leads ECB to aim higher with interest rate
- But Fed decision & U.S. economic data posing risk to recovery
Image © European Union - European Parliament, Reproduced Under CC Licensing.
The Euro to Dollar exchange rate entered the new week near nine-month highs and with scope to test the 1.10 handle if the latest Eurozone inflation figures lead the European Central Bank (ECB) to become more hawkish on Thursday, or if the U.S. Dollar remains under pressure.
Europe's single currency reached one of its best levels since April against a generally weaker Dollar on Monday but could rise further if Monday's Spanish inflation figures are any guide to how the Eurozone data are likely to come out on Wednesday.
The path higher is obstructed by technical resistance up around 1.0945 on charts but the Euro-Dollar rate could gain the momentum necessary to overcome it if inflation surprises on the strong side of expectations this Wednesday and leads the ECB to aim higher with its interest rate as a result.
"This obviously runs against the thesis that the worst for inflation in the euro zone has passed and will only strengthen the hand of the hawks on the ECB governing council who last week repeated the case for 50bp at the next few meetings," says Kenneth Broux, a strategist at Societe Generale.
"The spike in core especially is bad news and will simply add to the view that the return to target will be slow and interest rates will have to stay higher for longer," he adds in a Monday reference to the Spanish data.
Monday's Spanish data made clear that risks around Wednesday's Eurozone numbers are on the upside of a consensus that sees inflation ebbing from 9.2% to 9% this month and core inflation falling from 5.2% to 5.1%.
Higher inflation could be positive for the Euro-Dollar rate if it leads to a steeper increase in interest rates than otherwise, although ECB officials have indicated for weeks that they're already likely to lift borrowing costs half percent increments in each of the January and March policy decisions.
"At the current juncture, ECB hawkishness and rapid ECB tightening have a much better chance of sending the EUR higher — particularly if the Fed no longer has the wherewithal to shock investors with its own hawkishness," says Stephen Gallo, European head of FX strategy at BMO Capital Markets.
"We think a near-term prolongation of EURUSD strength to levels above 1.10 will raise numerous eyebrows at the ECB, considering the Euro Area's competitiveness challenges and an increasing risk of trade disputes. We see EURUSD as a near-term sell at or above 1.10," he adds.
While domestic developments may be more supportive of the single currency this week, there is also a Federal Reserve policy decision and busy schedule of U.S. economic data out this week, which could yet help the Dollar back onto its feet and dampen the recovery in EUR/USD.
"The rub here is that EUR is tactically stretched," writes Mark McCormick, global head of FX strategy at TD Securities, in a Friday research briefing.
"Our preferred entry point for long EURUSD exposure sits near 1.06 — the level consistent with our Global Macro PCA framework. We also note that EUR has overshot the model relative to SEK, NOK, and GBP. We continue to see long EURCHF as the cleanest play for EUR strength," he adds.
This week's U.S. data calendar sees labour cost figures released on Tuesday ahead of Institute for Supply Management (ISM) PMI surveys of the manufacturing and services sectors on Wednesday and Thursday, and then January's non-farm payrolls report on Friday.
The Dollar sometimes rises in response poorer-than-expected economic data, meaning the Euro may be vulnerable to any negative surprises.
Meanwhile, attention will also be on whether the Fed goes out of its way to reverse a recent loosening of financial conditions that has been led by declines in bond yields and has lifted EUR/USD significantly since November.
But this would require Federal Open Market Committee members' to overdeliver on market expectations for only a 0.25% increase in the Fed Funds rate to 4.75% on Wednesday, which would be the smallest increase since last March.