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EUR/USD Treads Water Ahead of Key ECB Rate Decision. What Should Traders Expect?

EUR/USD Treads Water Ahead of Key ECB Rate Decision. What Should Traders Expect?

Diego Colman, Market Analyst

EURO FORECAST:

  • EUR/USD is largely flat on Tuesday, trading around the 1.0700 handle
  • Volatility could pick up in the coming days, with the European Central Bank’s monetary policy decision on tap for Thursday, a high-impact event for the euro
  • The ECB is expected to announce the end of quantitative easing, setting the stage to begin raising rates next month

Most Read: Japanese Yen Price Action Setups - USD/JPY, EUR/JPY, GBP/JPY and AUD/JPY

The euro is largely flat against the U.S. dollar on Tuesday, trading around the psychological 1.0700 level, but volatility is likely to pick up in the coming days, bolstered by a major risk-event on Thursday’s calendar: The European Central Bank’s June Monetary Policy decision. At this gathering, the institution headed by Christine Lagarde is expected to formally announce the end of quantitative easing to take effect early in the third quarter, setting the stage to start the interest rate liftoff in July. Given that Lagarde has already signaled imminent moves in terms of hikes, the focus will be on the message regarding the speed of the tightening cycle.

With eurozone inflation at 8.1% year-on-year in May, the highest level on record and quadruple the 2% target, policymakers desperately want to be seen to be doing something to improve the precarious situation, but have yet to embrace a full-fledge hawkish stance amid fragmentation risks. There is, however, a rising probability that the bank could support a proposal to prop up vulnerable debt markets if regional yield spreads blow out as the normalization process gets underway.This backstop plan to counter any unwarranted rise in borrowing costs for the bloc's most heavily indebted countries could allow the ECB to turn more aggressive, leaving the door open to front-loaded policy adjustments later this year.

In light of recent developments and shifting monetary policy expectations, guidance will be key for foreign exchange traders. Any signs that the bank is starting to lean towards non-standard 50 basis points hikes at its next meetings could allow the EUR/USD to resume its recovery, but gains will likely be limited considering the U.S. dollar’s yield advantage enhanced by the Fed’s forceful tightening path.

Aside from the tone, market participants should also watch the updated quarterly macroeconomic projections. Inflation is likely to be revised sharply higher for this year, but less so for 2023 and 2024. GDP forecasts are also likely be downgraded for this and next year, a sign that the balance of risks for economic growth remains tilted to the downside. This lackluster backdrop should prevent a significant rebound of the common currency against the greenback heading into the second half of the year.

In terms of technical analysis, despite numerous attempts over the past few days, EUR/USD has failed move above cluster resistance, spanning from 1.0740/1.0785. Looking ahead, this area should continue to act as a barrier for price action, but if buyers manage to clear this hurdle, EUR/USD will have fewer obstacles to advance towards 1.0922, the 50% Fibonacci retracement of the 2022 decline.

On the flip side, if sellers return and downside pressure picks up pace, initial support stretches from 1.0650 to 1.0630. If this floor is breached, the focus shifts lower to the psychological 1.0500 zone, followed by the May low around 1.0350.

EUR/USD TECHNICAL CHART

EURUSD technical chart

EUR/USD Chart Prepared Using TradingView

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---Written by Diego Colman, Market Strategist for DailyFX

DailyFX provides forex news and technical analysis on the trends that influence the global currency markets.

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