EUR/USD X-Rate Recovery Forecast to be Limited by 1.12 Barrier

The euro to dollar rate fell to lows of 1.0913 in overnight trade as the single currency was hit by fears about the outlook for the integrity of the EU following Britain’s decision to vote to leave

The EUR/USD has recovered a substantial portion of its Brexit-inspired losses, returning to the 1.11s.

It has however not been able to close above the lower rising trend line that has defined trade in GBP/EUR since December 2015. 

This is technical confirmation that perhaps the pair is about to break lower.

Nevertheless, the exchange rate is currently sitting just above substantial layers of support at 1.1100 from two major moving averages (MA) -  the 50-week MA and the 200-day MA.

It would require a break below the spike lows, however, of 1.0913 for strong confirmation of an extension lower, with a target at 1.0700 calculated using the height of the channel as a guide, and extrapolating it lower.

Lloyds Commercial Banking’s Robin Wilkins argued the 1.11-12 level ought to cap upside, and risks were now tilted to further declines:

“The greater risk now though is for a deeper decline as renewed pressure politically is put on Europe. It raises the question of whether the range between 1.0460 and 1.16-1.17 peaks is a classic consolidation phase within the trend from ~1.60 setback in 2008, suggesting a move to test long-term key support in the 1.0-0.99 region. A rally back through the 1.11-1.12 region would at least shift us back into a range environment for now."

Helaba Research’s Ralf Umlauf now sees the EUR/USD pair operating in a new zone between 1.1150 and 1.0800:

“On the indicator side the sell signals dominate. A test of the important support around 1.05/08 cannot be ruled out in the medium term. Our favoured trading range: 1.0800 – 1.1150.”

Impact of Brexit on the US and rest of Europe

Whilst it is too early to gauge the fundamental impact of Britain leaving on the single currency, the evidence suggests it will not be negligible.

The former president of the ECB Jean-Claude Trichet, speaking on Bloomberg TV, said the ripple effects of Brexit would be felt all around the world and that, “the repercussion on central Europe.. is not negligible.”

However, he saw a qualitative difference in the UK’s stance on Europe and European integration and those of the majority of other EU members, suggesting that fears a Brexit might trigger a series of copycat referendums in the rest of the Eurozone might be overdone.

“We are not in the same universe from a cultural standpoint,” said Trichet.

In an early reaction to the news, however, Angela Merkel, said: “Today is a turning point for European Unification.” Indicating that she was more concerned about the future of the Eurozone and the euro currency, than Trichet.

Even if the euro side of the EUR/USD pair weakens as a result of fears about other members exiting, as well as the potential negative economic impact caused by Brexit uncertainty, the dollar may also come under pressure.

The dollar index has strengthened in the aftermath of Brexit, rising 2.75% to 95.90, however, this will probably act as a disincentive to the Federal Reserve (Fed) from continuing with more interest rate increases this year, and this would be expected to weigh on the currency over time.

Nevertheless CIBC's Jeremy Stretch suggests the dollar may remain strong despite Fed delay as a result of safe-haven flows:

"Post the Brexit vote, we expect that US rate expectations are set to diminish; expect the Fed to invoke global concerns as justification for inertia. However, we can expect the USD to remain well supported should risk appetite remain compromised."

And he adds:

"The realisation that a Brexit vote is almost as worrisome for the Eurozone as it is for the UK suggests that EUR USD rallies are likely to run into ongoing selling interest."