ECB & Fed on Opposite Ends: Which Currency Will Win Out?

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The EUR/USD is one of the world’s leading major currency pairs. It is currently trading at 1.1206, up slightly for the day. For the year to date, the EUR/USD pair has gained 6.66%, but recent declines since the European Central Bank’s meeting have led to a modest strengthening of the USD. Last week, the ECB decided not to make any changes to the benchmark interest rate.

More importantly, ECB president Mario Draghi made no mention of lowering interest rates in the future. Currently, the refi rate is 0%, and interest rates on deposit facilities are now at -0.40%, with lending rates at 0.25%. These historically low interest rates are helping to increase the velocity flow of money through the European economy, thereby stimulating economic growth, investment, and lines of credit.

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On Monday, 12 June 2017, the EUR/USD pair showed bullish movement, as it moved towards 1.1242. However, currency traders are not convinced that the current short-term rally can sustain itself, and a pullback towards the 1.1100 level may be on the cards. Most analysts agree that the EUR/USD pair is going to run out of steam shortly.

Once this occurs, we could soon be broaching the 1.1050 level, as we head towards the 1.100 level. Currently, the US dollar index (a measure of the USD against 6 currencies) is trading at 97.23. Over the past 5 trading days, the DXY is up 0.44%, but down 5.04% for the year to date. This dovetails with the current performance of the EUR/USD pair for the year to date.

Where to next for the EUR/USD pair?

The European Central Bank is likely to leave interest rates unchanged for the foreseeable future. According to Mario Draghi, the economic growth projections appear broadly balanced, but there is no indication that this is moving towards higher inflation rates. Draghi is insistent that quantitative easing remains the most important monetary policy tool to drive up inflationary pressures in the euro zone.

Weakness in crude oil is helping to keep inflation rates in check, and lower food prices are expected. Real wage growth remains a concern in Europe, and unemployment needs to continue decreasing to pick up the slack. Currently, the quantitative easing (QE) measures have the ECB purchasing €60 billion per month through December 2017 to get inflation where it is supposed to be – the 2% level.

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The central bank is fully prepared to extend the current policy of monetary accommodation beyond December 2017, if required. The EUR/USD pair briefly consolidated around the 1.1200 level in the late trading session on Monday, but ultimately broke to the upside as US treasury bonds generated weaker yields. This dragged the USD lower against its rivals. There is definitely a degree of caution ahead of Wednesday’s Fed decision, and currency traders are a little skeptical about taking big positions on the pair with a 25-basis point rate hike in the offing.

Indices across Europe are down, but geopolitical realities tend to favour the European currency over the US one. The recent victory of Emanuel Macron in the French presidential election is a case in point. The current probability of a Fed rate hike is now at 99% according to the CME Group Fedwatch tool. But what is concerning for the USD is that there aren’t strong possibilities of additional rate hikes beyond that.

The short-term prognosis is bullish for the EUR/USD, and all the technical indicators point in that direction. However, a supportive statement from the Fed could strengthen the greenback and reverse these gains on Wednesday.