EUR/USD Rate "Could Go Well North of 1.10": City Index Fed and ECB Preview

By Fawad Razaqzada, Market Analyst at City Index and FOREX.com. Image © Adobe Images

The EUR/USD is clearly going to be in focus this week with both the Fed and ECB rate decisions to come ahead of U.S. non-farm payrolls report on Friday.

The stickiness of Eurozone inflation means there is a greater risk for a hawkish surprise, potentially leading to a bullish breakout above the 1.10 handle on the EUR/USD.

At the time of writing though, the EUR/USD bears were exerting some pressure.

For now, the battle around 1.10 continues on the EUR/USD, with rates falling below this handle at the start of this week on the back of a stronger IMP PMI report and a surprise 2.4% drop in German retail sales.

However, Eurozone CPI inflation edged up to 7.0% in April from 6.9% previously, while core CPI edged down a tad to 5.6% from the record 5.7% the month before.

Both measures were bang in line with the estimates, though.

With key risk events ahead of us, speculators appear unwilling to commit in either direction as there remains some uncertainty in terms how much tightening we will get from the two central banks.

Clearly, both the bulls and the bears will want to hear it straight from the horses' mouths before committing on the long or short side.

The ECB's benchmark interest rate is at its highest level since 2008, at 3.5%. ECB members have continued to make hawkish noises ahead of the May policy meeting, although the lack of forward guidance in March means it remains uncertain how much tightening we will get this time.

After two consecutive 75bp hikes, the ECB dropped to 50bp over the past three meetings and it's possible we could see them drop to 25bp this time.

The market is pricing around two more rate hikes from the ECB in this cycle.

But it appears as though there's only been a limited impact from the banking turmoil, while the Eurozone economy has avoided a severe recession.

Image courtesy of City Index.

Given that inflation remains sticky and well above target, this raises the possibility we will get a hawkish surprise from the ECB on Thursday, especially if the Fed meeting the day before is not too dovish.

This could either be in the form of a 50-bps hike or a 25-bps hike plus some hawkish commentary around it – for example, hints of several further rate increases.

Assuming that the Fed does not deliver any major surprises on Wednesday, the EUR/USD could go well north of 1.10 in the event of a hawkish surprise from the ECB on Thursday, either in the form of a 50-bps hike or a hawkish forward guidance accompanying a 25-bps hike.

However, a dovish rate hike could see the EUR/USD drop to 1.0800.

For example, the ECB could highlight the risk of a sharper or longer-lasting economic slowdown, one that puts any further rate increases in doubt or at best “data-dependent.”

The other side of the equation of course is the US dollar, which will come under the spotlight on Wednesday with the Fed’s rate decision and again on Friday with the release of U.S. nonfarm payrolls report.

Whilst concerns over weaker US data and mid-tier banks is bubbling away in the background, the odds continue to favour another 25bp Fed hike to 5.25%, which the market pricing implies will be the terminal rate.

Yet, comments from Fed officials remained hawkish into the blackout period.

So, look for clues to decipher whether it is a hawkish hike (+25bp with more to follow), or a dovish one. If it is the latter, then any dovish surprises from the ECB will have less of a negative impact on the EUR/USD than would have otherwise been the case.

Ahead of the ECB and Fed rate decisions, the EUR/USD continues to coil inside a tight range, around 1.1000.

For now, the bullish trend is kept alive, although momentum is not there.

Still, support is being provided in the dips. So far, the region between 1.0900 to 1.0950 has firm on several occasions.

This is also where the 21-day exponential moving average comes into play.

For as long as rates hold above this area, the bulls will be happy.

Otherwise, the bullish momentum will fade further, discouraging the bulls to stick around.