Written by: Rania Gule, Senior Market Analyst at XS.com
The EUR/USD pair recorded notable gains during Friday’s trading, approaching the 1.0500 level, driven by the U.S. dollar relinquishing its daily gains. In my opinion, this movement is primarily due to the decline in the U.S. Dollar Index (DXY), which faced selling pressure above the 107.00 level. Interestingly, the U.S. dollar has lost its momentum despite expectations of hawkish signals from the Federal Reserve on interest rates, especially following a likely 25-basis-point rate cut in the most recent meeting.
This shift in the dollar’s trajectory reflects the divergence between market expectations and the Federal Reserve’s stance. Traders anticipate another 25-basis-point rate cut, potentially bringing interest rates to 4.25%-4.50% during the January meeting.
However, some believe that the Federal Reserve may need to reassess its approach given the slowing pace of economic contraction and the sustained strength of the U.S. labour market. For instance, reports indicate that the unemployment rate remains below the Fed’s projections, signalling continued economic activity. Additionally, the U.S. Producer Price Index for November accelerated beyond expectations, suggesting that inflationary pressures have not fully subsided.
On the other hand, the European Central Bank’s (ECB) monetary policy appears more inclined toward easing, which exerts pressure on the euro. Statements from ECB officials such as François Villeroy de Galhau and Martins Kazaks emphasized the need for additional rate cuts to support the slowing economy. ECB President Christine Lagarde also highlighted that the deteriorating growth outlook in the Eurozone necessitates further monetary easing. In my view, this reflects European policymakers’ concerns over the adverse effects of declining exports and weak business investment on economic activity.
The ECB faces multiple challenges, as new forecasts suggest that the Eurozone economy will grow at a slower pace than previously anticipated over the next two years. While Lagarde expressed cautious optimism about inflation returning to the 2% target by 2025, she also voiced concerns about the short-term impact of elevated U.S. tariffs on inflation. This pessimistic outlook for Eurozone growth complicates the euro’s ability to achieve sustained gains against the U.S. dollar.
Recent economic data, however, indicate a relative stabilization in Eurozone industrial production for October, following a sharp contraction in September. Nevertheless, this stabilization does not conceal the ongoing slowdown in industrial activity, with year-on-year industrial production declining by 1.2%. Although this decline was less severe than expected, it still raises concerns about the recovery’s momentum.
Given this backdrop, it seems to me that markets are swaying between contrasting monetary policies in the U.S. and the Eurozone. In the U.S., the Federal Reserve remains under pressure to balance inflation control with economic growth, potentially leading to more hawkish policies in the near term. Meanwhile, the ECB appears committed to rate cuts to support its struggling economy, weakening the euro’s position against the dollar.
From my perspective, the current EUR/USD landscape reflects a cautious market environment responding to mixed signals from central banks. While the U.S. dollar could face additional selling pressure if the Federal Reserve eases its rate hike pace, the euro remains vulnerable to the ECB’s accommodative policies. As a result, I anticipate the pair to remain range-bound until greater clarity emerges on monetary policy directions on both sides.
In conclusion, the EUR/USD pair finds a delicate balance between opposing forces. In the short term, price movements are likely influenced by economic developments and statements from central bank officials. However, in the longer term, growth and inflation dynamics will remain the key determinants of direction. It is crucial to monitor new signals from both the Federal Reserve and the ECB to gauge the future trajectory of this pair in the forex markets.