Euro-Dollar Week Ahead Forecast: Hanging in the Balance as ECB Takes Stage

- EUR/USD supported at 1.1777 but vulnerable to USD & ECB
- ECB rates, PEPP, QE seen unchanged but new guidance eyed
- Other action possible to meet new targets, in quiet data week
- EUR/USD underpinned at 1.1700; resisted at 1.1880, 1.1940

Image © Pound Sterling Live

• EUR/USD reference rates at publication:
• Spot: 1.1800
• Bank transfers (indicative guide): 1.1390-1.1480
• Money transfer specialist rates (indicative): 1.1705-1.1730
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The Euro-to-Dollar exchange rate outlook hangs in the balance ahead of Thursday’s all-important policy update from the European Central Bank, which is pivotal to whether the single currency can sustain itself above nearby support at 1.1777, or if it succumbs to a steadily advancing greenback.

Europe’s unified unit entered the new week above 1.18 and having shown continued resilience in the face of a six-week long advance by its U.S. counterpart, which saw the Euro-Dollar rate briefly test a key level of technical support around 1.1777 last week before recovering.

The Euro has fallen beneath 1.18 four times in recent sessions only to draw a bid from the market soon after, which has heartened observers of the charts, some of whom have been tempted to wager that the Euro could soon attempt another run toward the 1.19 handle.

“EUR/USD has so far held over the 2020-2021 support line at 1.1777 on a closing basis. It is trying to stabilise, but will face tough overhead resistance at 1.1884/95, the highs from last week and the 23.6% retracement. Currently the Elliott wave count is implying the rally is corrective only and is likely to terminate around 1.1940,” says Karen Jones, head of technical analysis for currencies, commodities and bonds at Commerzbank.

Jones and the technical analysis team at Commerzbank bought the Euro-Dollar rate last week at 1.1836 and 1.1815 while advocating that clients of the bank do the same in anticipation of an attempted recovery of the 1.19 level, though they also suggested reducing positions around 1.1880.

The outlook for the single currency is hanging in the balance however, and whether it holds above the recently-tested support at 1.1777 through the new week is likely contingent upon Thursday’s European Central Bank (ECB) decision, the market’s response to it and whether the Dollar continues to creep higher.

Above: Euro-Dollar at daily intervals with Fibonacci retracements of 2020 recovery, support line cited by Commerzbank and U.S. Dollar Index.

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“We look for a limited upside to trade-weighted dollar next week. Not only is it a fairly calm week on the US data front (suggesting limited catalysts for a domestically driven USD rally), but the possibly cautious / dovish ECB next week can provide a boost to cyclical FX, which would also spill over into the USD crosses (though EUR/USD would still decline),” says Petr Krpata, chief EMEA strategist for FX and interest rates at ING.

There’s little by way of major European or U.S. economic data to guide the Euro and Dollar ahead of Thursday’s 12:45 ECB policy decision and 13:30 press conference, although Friday morning sees July’s Flash PMI surveys of the Eurozone’s manufacturing and services sectors released by IHS Markit.

“We do not expect any changes to its policy rates or the pace of asset purchases. Otherwise, we think that the flash PMIs probably rose further in July, which would suggest that Q2’s rebound will be sustained into Q3,” says Jack Allen-Reynolds, an economist at Capital Economics.

The latter will provide insight into the pace of recovery in key engines of Europe’s economy at the beginning of the current quarter although after strong increases earlier in the year, and since many European capitals have recently become more concerned about emergent editions of the coronavirus, the danger there is they signal a cooling off.

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"Look for strengthened guidance around the confidence on inflation the ECB will need to raise rates. Look also for guidance on asset purchases well beyond March 2022," says Giovanni Zanni, chief Euro Area economist at Natwest Markets, referring to Thursday's ECB decision.

"The ECB wants to see actual evidence of a sustained increase in underlying inflation dynamics before even thinking about a taper," Zanni adds.

The ECB’s update forms the highlight of the week for the Euro and is widely expected to see the bank’s three different interest rates left unchanged along with the parameters of its Pandemic Emergency Purchase Programme and the pre-pandemic Asset Purchase Programme.

The market will listen closely on Thursday nonetheless in order to hear formally what the bank's new, higher and officially symmetric 2% inflation target will mean for its monetary policy going forward.

“Decisive ECB policy action to back up the new policy framework could trigger a fresh EUR sell off next week at a time when other major central banks (BoE & Fed) are moving closer to raising rates. A failure to act would provide some relief for the EUR,” says Derek Halpenny, head of research, global markets EMEA and international securities at MUFG.

"It would be underwhelming if the ECB just updates their forward guidance," Halpenny says.

Above: MUFG graphs showing change in EUR/USD six hours after the eight most recent ECB decisions.

The ECB’s decade-long difficulty in meeting the old inflation target of “below but close to 2%”ought to necessitate an even larger amount, or simply longer period of quantitative easing than in the past, which is typically negative for currencies and there aren’t many analysts tipping this the ECB's decision as likely to be positive for the Euro.

However, the single currency Euro rose in the hours after the ECB first announced the outcome of the strategic review which spawned the new targets, potentially indicating that some form of policy action would be required to weaken it this time around.

“Potential options on the table for policy action include committing to faster PEPP purchases beyond Q3 and/or extending the likely end date of PEPP beyond Q1 2022,” MUFG's Halpenny says.

Halpenny and the MUFG team also say the ECB could potentially leave its €1.85 trillion coronavirus-inspired PEPP programme to run until the end of March when it's expected to begin being wound down but provide forward guidance tipping of a bolstering of its original QE programme known as the APP, which was always set to survive the bank's pandemic era bond purchases.

Any such action could be at least a temporary headwind for the Euro-Dollar rate whereas an omission of it might see the ECB’s July decision having a more neutral impact on the single currency and in the process enable EUR/USD to defy gravity for another week.

Above: Euro-Dollar rate shown at daily intervals with Fibonacci retracements of late May decline indicating possible resistances.