The European currency ended February with slight gains against the US dollar. However, this week, the EUR/USD pair risks resuming a decline ahead of the ECB's monetary policy meeting. If the regulator openly starts preparing the ground for rate cuts, the euro will face a steep sell-off.
ECB meeting: what to expect and prepare for?
The European Central Bank will hold a monetary policy meeting on Thursday, March 7. The regulator s widely expected to keep interest rates unchanged, so all investors' focus will be on updated economic forecasts and any signals regarding the timing of rate cuts.
Market participants are leaning towards the ECB beginning to ease monetary conditions in the second half of the year, specifically at the June meeting.
This scenario was reinforced by recent statements from European officials. Most members of the central bank called June the most likely month for rate cuts, emphasizing that premature actions could trigger another round of inflation.
Meanwhile, price growth in the euro area continues to slow down steadily. Data published last week showed that annual inflation fell to 2.6% in February from 2.8% a month earlier.
Wage growth, one of the main indicators for the ECB in assessing inflation, also started to slow down but remained at a high level.
This factor is currently preventing the regulator from a dovish policy shift, which, according to economists, poses a significant risk to the European currency.
According to analyst Marios Hadjikyriakos, delaying interest rate cuts for too long could cause unnecessary damage to the European economy and lead to a situation where rates are eventually cut sharply and abruptly. This paints a grim picture for the euro, even if the ECB calls for patience this week.
However, let's not jump ahead and focus on the near-term prospects of the European currency, which depend on the ECB's rhetoric at the upcoming meeting.
ING analyst Carsten Brzeski believes that the March meeting cannot be considered routine. As inflation in the EU continues to decline and the European economy remains weak, interest rate cuts will be subject of heated debate.
He is confident that persistent core inflation, uncertainty regarding wage dynamics, and enduring confidence in the EU economic recovery will not allow the regulator to cut rates in March. However, Brzeski believes that the central bank will definitely change its rhetoric, thus preparing the ground for rate cuts in June.
What should traders pay attention to during the ECB meeting? Here are three key points:
Recall that in December, the ECB anticipated inflation to be at 2.7% this year and 2.1% next year. Any downward revision of the price growth forecast for 2024 and 2025 will likely open the door for earlier rate cuts in the EU, which could exert significant pressure on the euro.A "balanced" risk assessment of the inflation outlook would be a strong signal in favor of rate cuts,. Brzeski noted.
The ECB is not one of those regulators that quickly change its policy stance. It took several months to move from "we didn't even spell 'rate cuts" to "it is too early to discuss rate cuts." But if this time things are different, the euro is doomed to fall.
If the bank says that members "had a first discussion on preconditions for rate cuts" or "we decided to start this discussion at the next meeting", this would mark a further shift in the direction of policy easing, ING believes.
Currently, the eurozone economy is not in a recession, but concerns about a slowdown in economic growth persist.
Last year, Germany's economy, the largest in the EU, was particularly hard hit. The slowdown in global trade severely damaged its export-oriented business model.
If the regulator voices concerns about a further downturn in the region at the March meeting, it could fuel speculation about a deeper ECB cut this year.
Currently, the market expects the EU rates to be cut by 90 bps by the end of the year. A similar reduction is forecasted in the US as well.
However, if the forecast regarding European rates is raised, EUR/USD is set for an inevitable fall. The American economy looks much more resilient at the moment, leading to speculation that the Fed could avoid a pivot this year.
Why does the dollar have a better chance?
With a strong US economy, the dollar is currently the most effective major currency this year. Since the beginning of January,its exchange rate has added almost 3% against its main competitors.
Gloomy economic prospects elsewhere also favor the dollar. The UK and Japan have entered a technical recession, the euro area is plagued by stagnation, and China is still grappling with a real estate market crisis.
As we see, there is simply no alternative to the dollar at this stage, and this week's events may further underscore the dominant role of the American currency.
On Wednesday and Thursday, all eyes will be on Fed Chair Jerome Powell's speech to Congress. The policymaker's assessments regarding further economic prospects in the US will be of crucial importance to the market.
If the head of the Fed expresses optimism, it could further dampen expectations regarding the Fed's future dovish policy, thus supporting the dollar.
On Friday, traders will shift their focus to the most important event of the week - the release of the latest US employment report. Economists expect another round of robust job data, confirming that the American labor market remains in good shape.
This could also strengthen investors' belief that the Fed will not rush to cut rates this year, giving a boost to the greenback across the board, including against the euro.
Currently, investors have almost entirely ruled out a cut in the US in March and April. Most market participants expect the Fed to start cutting rates at the June meeting.
However, some analysts believe that this may happen much later or not at all this year. For example, economist Torsten Slok holds such a view. In support of his theory, the expert presents 10 arguments:
- The American economy is not only maintaining its pace but also gaining new momentum, with improved growth forecasts.
- Indicators tracking inflation trends continue to rise.
- The core inflation rate closely monitored by Federal Reserve Chair Jerome Powell is also increasing.
- The US labor market remains resilient.
- Surveys among small business representatives indicate their plans to raise product prices.
- Research in the manufacturing sector shows an increase in paid prices, which is a harbinger of inflation.
- A similar trend can be seen in the service sector.
- Surveys among small businesses show that more and more employers plan to increase wages.
- Landlords are raising rates, and the cost of housing continues to rise.
- Financial conditions in the country continue to improve, creating a favorable economic environment.
Therefore, if traders receive further evidence this week that the American economy is on the rise, it may cause investors to abandon forecasts of an imminent rate cut in the US. In such a scenario, the dollar has a chance to gain strong upside momentum against the euro.
EUR/USD technical analysis
Considering the long-term downward trend in the euro/dollar pair and the medium-term technical indicators that clearly favor bears, it can be assumed that the most likely scenario suggests a downward movement.
The resistance area of 1.0860-1.0846 on the one-hour chart may halt bulls' attempts to drive the quotes up, creating favorable conditions for selling with the view to reaching the support level of 1.0789.
The fact that the asset is testing the lower boundary of the 200-day moving average suggests a potential decline in EUR/USD to the support level of 1.0739 and then to the next support level of 1.0516.
