Euro-Dollar: Too Soon to Bet on a Selloff says City Index Analyst

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It is too soon to bet against the Euro with Thursday's European Central Bank policy meeting likely to keep the door open to another interest rate hike in September, according to an analyst we follow.

Fawad Razaqzada, an analyst at City Index, says his base case scenario is the ECB strikes a balance in its policy decision on Thursday, one that would potentially keep the Euro to Dollar rate's (EURUSD) outlook mildly positive.

"Lagarde may hone in on the "higher for longer" narrative in order to counter speculation that the ECB will start cutting interest rates next year, when 75 basis points of cuts are priced in. But “higher for longer” may just mean a longer pause than further hikes," he says in a new note.

Such a communication would probably keep the door wide open for a potential hike in September, rather than pre-committing to it in light of renewed weakness in the Eurozone economy – especially in the manufacturing sector, explains Razaqzada.

"In this scenario, I don’t think the EUR/USD will fall materially in terms of initial reaction and will likely remain around the 1.10 handle once the dust settles, before potentially resuming higher," he adds.

The Euro has retreated from recent highs following comments from prominent ECB Governing Council members that sought to warn markets that a rate hike in September was no longer a done deal.

Heading into last week the market was positioned odds-on for a September rate hike, an assumption that underscored the Euro's rally.

But a typically 'hawkish' ECB Council member, Klaas Knot, said in an interview September was not guaranteed to bring with it another rate hike. His caution was underscored on Monday by softer-than-expected Eurozone PMI data that signalled the bloc's economy went into reverse in July.

A dovish outcome for Euro exchange rates would be if the ECB signals that inflation could return to target sooner than expected because of a significant deterioration in the Eurozone's economy, says Razaqzada.

"The single currency could break sharply below the $1.10 handle. In our view, this scenario is less likely to be the case given how hawkish Lagarde was in the previous meeting just over a month ago," he explains.

Above: EURUSD technical analysis courtesy of City Index.

An outright bullish case, that would see the Euro rise, involves the ECB pointing to core inflation remaining sticky and overlooking recent signs of economic slowdown in the Eurozone.

This was the stance adopted in June when the ECB pre-committed to another rate increase in July.

"In this scenario, the EUR/USD could rally towards 1.1300, above the recent 2023 high made last week," says Razaqzada.

From a technical perspective, City Index reckons the Euro-Dollar outlook remains bullish, despite its recent pullback.

"This is because we haven’t yet seen a major topping pattern or a lower low to suggest the long-term bullish trend has ended," says Razaqzada. "If anything, the EUR/USD is now at a potentially important support zone, between 1.100 to 1.1095 region."

Previously a ceiling on several occasions this year, we could see the EUR/USD rebound and push higher again from this area, according to the analysis.

"The line in the sand is at 1.0833 for me. This being the last low hit in early July, prior to the latest rally to a new 2023 high earlier last week. If we break below this level, then we will have created out first lower low. At that point, therefore, I would drop my bullish EUR/USD outlook," says Razaqzada.

He notes too that last week’s high came right in around the 61.8% Fibonacci retracement level (1.1275) of the big downswing that started in January 2021. This level is now the key target for the bulls to claim.

"If they do so successfully, then there’s not many further resistances until 1.1500," says Razaqzada.