EUR/USD Tries to Find Reprieve after the ECB-Induced Slump but the Fed Looms

EUR/USD Analysis

The European Central Bank hiked rates by 0.25% on Thursday, which marked the tenth straight move, in the most aggressive tightening cycle in its 25-year history. Inflation has been moderating, but is still far from the 2% target and the ECB expects it "to remain too high for too long", raising its forecast for both 2023 and 2024. ^[1]

However, policymakers hinted that rates may have now peaked, saying they have reached levels that "maintained for a sufficiently long duration, will make a substantial contribution to the timely return of inflation to our target". Officials are in a bind, as they contemplate the bloc's poor economic performance, revising their GDP forecasts lower for 2023 and the next year. Germany is a particular source of worry, with the EU Commission expecting it to contract by 0.4% this year. ^[2]

Investors now await the Eurozone inflation figures on Tuesday and the Fed's pivotal policy decision on Wednesday, which will determine the trajectory of EUR/USD. The US central bank has slowed the pace of tightening in 2023, as it comes closer to the end. Markets price in a hold for at this meeting and believe that the terminal rate has been reached, although there is less conviction around the latter.

Inflation has eased substantially, but remains highs, while the labor market and the economy are strong, despite signs of softening. Chair Powell had kept the door firmly open to more tightening at Jackson Hole ^[3]. Focus now will be on the updated dot-plot and what's next.

EUR/USD runs a nine-week losing streak on the Fed's higher-for-longer prospects and the unraveling of the Euro's rate advantage and slumped on Thursday, after the ECB's dovish hike. It risks breaking below the key 1.0611 (38.2% Fibonacci of the 2022 low/2023 high advance), which would expose it to the 2023 lows (1.0481).

On the other hand, the ECB may have a hard time staying on the sidelines, given persistent inflation and President Lagarde did not shut the door to more hikes, noting that "we can't say that now we are at that peak"^[1]. EUR/USD reacted on Friday and defended the pivotal 38.2% Fibonacci. This may give it the opportunity to rebound towards the resistance confluence at 1.0800-1.0830. Daily closes above it could halt the bearish bias, but the common currency does not inspire confidence for sustained recovery under current conditions.