- Stronger-than-expected US inflation figures and signals of continued tightening of US central bank policy helped bears drive the EUR/USD currency pair towards the 1.0726 support level in Thursday's trading ahead of the European Central Bank's announcement.
- Furthermore, the euro-dollar had earlier in the week erased its gains, which had reached the 1.0885 resistance level, after the US inflation reading left the European Central Bank high and dry in June.
- The higher US inflation means that the ECB will cut rates before the US Federal Reserve, creating a policy divergence that will weigh on the euro-dollar exchange rate.
According to forex trading platforms, the US dollar rose sharply against other major currencies after US inflation hit 0.4% on a monthly basis in March, bringing the annual change to 3.5%, up from 3.2% in February. The core, "super core" and services components showed that upward pressure on domestic inflation was rising, not falling, as the Fed had hoped by this time.
According to forex trading, the most popular currency pair in the market increased its losses after the release, as markets priced in a lower probability of a Fed rate cut at the June policy meeting. In fact, the chances of a rate cut in July also declined, with September emerging as the most likely date for a start. Overall, futures markets show that investors are now pricing in about 45 basis points of cuts by the end of the year, down from about 70 basis points just a day earlier.
Economic Outlook
Core inflation, which excludes volatile food and energy prices and is therefore a key factor in determining the underlying trend, was 0.4% in each of the past three months, bringing the annual rate to 4.5%. This is well above the levels the Fed can tolerate. Overall, this inflation data comes on the eve of the European Central Bank (ECB) policy decision, where interest rates are expected to remain unchanged and new guidance will be issued indicating a rate cut in June.
Moreover, the ECB had been ignoring market bets on a June start date for some time, noting that the same market prices showed the Fed would also be cutting rates at that time. According to analysts, "The question for the ECB is whether it will stick to its data-dependent approach or prefer a monetary policy strategy that is 'Fed-dependent'." Also, "Fed-dependent" means that the ECB prefers a risk-control strategy by acting "in line with the Fed".
The prospect of the two central banks moving in tandem has underpinned EUR/USD valuations for several months now, ensuring a steady sideways trend in the exchange rate. Thus, this stability will be called into question if the Fed and ECB diverge, with the euro likely to come under pressure if the ECB moves to cut rates sooner and faster.
EUR/USD Technical analysis and forecast:
A move of the EUR/USD price below the psychological level of 1.0800 will strengthen the bears' control over the direction. Furthermore, we have emphasized the importance of the reaction to US inflation announcements and the content of the recent Federal Reserve meeting minutes. Indeed, the momentum has been stronger for the dollar, and now we are on the verge of the next support at 1.0700, further reinforcing the bears' position.
If the European Central Bank abandons its hawkish tone today, there may be opportunities to move towards support levels at 1.0655 and 1.0580 respectively, which are sufficient to push all technical indicators towards strong selling saturation.
Ultimately, we still believe that any gains for the EUR/USD will be limited and short-lived.
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