It is too early to bet on the euro as the European Central Bank's monetary policy meeting tomorrow, Thursday, is likely to keep the door open for another rate hike in September, according to Fouad Razakzadeh, an analyst at City Index.
The analyst reported that his baseline scenario is that the ECB is balancing its policy decision on Thursday, something that is likely to keep the EURUSD price outlook somewhat positive. He also said, “Lagarde may focus on the ‘higher for longer’ narrative in order to counter speculation that the European Central Bank 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 from further rate hikes."
Such a call would likely keep the door wide open for a potential rally in September, rather than pre-commit to it in light of the renewed weakness in the eurozone economy – especially in the manufacturing sector.
“In this scenario, I don't think the EUR/ EUR/USD is materially lower in terms of an initial reaction and is likely to remain near the 1.10 handle once the dust settles, before resuming a potential rally,” he said.
The euro pulled back from its recent gains following comments from prominent ECB Governing Council members who sought to warn markets that a September rate hike was no longer a done deal. Going into last week, the markets were pricing in the odds of a rate hike in September, an assumption that confirmed the euro's rally. But a "hawkish" ECB council member, Claes Nott, said in an interview in September that he was not guaranteed to bring another rate hike with him. His caution was underlined on Monday by weaker-than-expected Eurozone PMI data that indicated a reversal in the bloc's economy in July.
A pessimistic outcome for euro exchange rates would be if the European Central Bank indicated that inflation could return to target sooner than expected due to the significant deterioration in the eurozone economy, the analyst also explained that: “The single European currency could break sharply below the $1.10 psychological level.”. In our view, this scenario is unlikely to be the case given how hawkish Lagarde was at the previous meeting just over a month ago.
An outright bullish case, which would see the euro rally, includes the European Central Bank signaling core inflation to hold steady and ignoring recent signs of an economic slowdown in the eurozone. This was the position adopted in June when the European Central Bank pre-committed to another rate hike in July.
“In this scenario, the EUR/USD pair may rise towards 1.1300, above the 2023 high it recorded last week,” he added.
EUR/USD Technical Outlook
From a technical point of view, City Index believes that the outlook for the euro and the dollar remains bullish, despite the recent decline.
“This is because we have not yet seen a major top or lower bottom pattern to indicate that the long-term uptrend is over,” the analyst stated, “If anything, EUR/USD is now in a potential support zone between 1.100 to 1.1095,” he added.
The analyst also notes that last week's high came near the 61.8% Fibonacci retracement level (1.1275) of the large bearish swing that started in January 2021. This level is now the main target for the bulls. And if they succeed, there will be no more resistance until 1.1500.
