EUR/USD drops as Fed to support more gradual rate cut approach

• EUR/USD trades subduedly near 1.0500 as the US Dollar stays broadly firm on expectations that the Fed will cut interest rates but deliver hawkish guidance for 2025.
• ECB officials see the continuation of the gradual policy-easing cycle as appropriate.
• The collapse of German Scholz’s government has paved the way for general elections on February 23.

EUR/USD stays under pressure near the psychological resistance of 1.0500 on Tuesday. The major currency pair remains fragile as the US Dollar (USD) gains on expectations that the Federal Reserve (Fed) will adopt a slightly hawkish stance after reducing its key borrowing rates by 25 basis points (bps) to 4.25%-4.50% on Wednesday.

The US Dollar Index (DXY), which tracks the Greenback’s value against six major currencies, ticks higher above 107.00.

According to the CME FedWatch tool, traders have priced in a 25 bps interest rate reduction for Wednesday's policy meeting. The data also shows that the Fed is expected to leave interest rates unchanged in the January meeting.

Analysts at Macquarie said that the Fed’s stance could turn “slightly hawkish” from “dovish” on the assumption that the “recent slowdown in the pace of US disinflation, a lower Unemployment Rate than what the Fed projected in September, and exuberance in US financial markets are contributing to this more hawkish stance.”

On the economic data front, United States (US) monthly Retail Sales data for November have come in better than expected. Retail Sales, a key measure of consumer spending, rose by 0.7%, faster than estimates and the prior release of 0.5%.

Daily digest market movers: EUR/USD drops as ECB backs more interest rate cuts

• EUR/USD remains fragile near the psychological resistance of 1.0500 in Tuesday’s North American session. The major currency pair struggles to break above the aforementioned hurdle as its broader outlook of the Euro (EUR) is bearish amid firm expectations that the European Central Bank (ECB) will reduce interest rates at every meeting until June 2025.
• The ECB has delivered a 100-bps interest rate reduction this year and is expected to loosen its monetary policy further by a similar margin next year, given that officials are confident about Eurozone inflation returning to the central bank’s target of 2%. Also, ECB policymakers have become worried about growing economic risks due to weak demand and potential tariffs from incoming US President-elect Donald Trump.
• After the decision to cut rates on Thursday, a number of ECB officials, including President Christine Lagarde, have agreed to the need for more interest rate cuts. On Monday, Lagarde said that the ECB "will cut rates further if incoming data confirm that disinflation is on track". Lagarde's dovish remarks on the policy outlook were backed by the assumption that "inflation momentum for services has dropped steeply recently."
• ECB executive board member Isabel Schnabel, who remains an outspoken hawk, also agreed to a gradual removal of policy restrictions. “Lowering policy rates gradually towards a neutral level is the most appropriate course of action,” Schnabel said at an event in Paris on Monday. However, she warned that the ECB should remain vigilant to any “shocks that have the capacity to destabilize inflation expectations.”
• In the European session on Tuesday, ECB policymaker and Governor of the Bank of Finland also delivered dovish remarks on interest rates. Rehn said, "The direction of our monetary policy is clear" as "inflation is more clearly starting to stabilize at the 2% target". Rehn refrained from guiding a specific interest rate path saying that "the speed and scale of rate cuts will be determined in each meeting".
• On the political front, the German parliament has passed the no-confidence motion against Chancellor Olaf Scholz’s government, which paved the way for general elections on February 23. According to market expectations, conservative challenger Friedrich Merz would defeat Scholz.
• On the economic data front, the German IFO sentiment surveys for December have shown that Business Climate and Expectations at 84.7 and 84.4, respectively, have come in weaker than expected. IFO Current Assessment, an indicator of current conditions and business expectations, surprisingly rose to 85.1 from 84.3 in November.

Technical Analysis: EUR/USD wobbles near 1.0500

EUR/USD continues to face pressure near the psychological figure of 1.0500 for the last four trading days. The major currency pair drops after facing resistance near the 20-day Exponential Moving Average (EMA), which trades around 1.0540, suggesting that the near-term trend is bearish.

The 14-day Relative Strength Index (RSI) revolves around 40.00. The bearish momentum should trigger if the RSI (14) falls below 40.00.

Looking down, the two-year low of 1.0330 will provide key support. Conversely, the 20-day EMA will be the key barrier for the Euro bulls.

ECB FAQs

What is the ECB and how does it influence the Euro?

The European Central Bank (ECB) in Frankfurt, Germany, is the reserve bank for the Eurozone. The ECB sets interest rates and manages monetary policy for the region. The ECB primary mandate is to maintain price stability, which means keeping inflation at around 2%. Its primary tool for achieving this is by raising or lowering interest rates. Relatively high interest rates will usually result in a stronger Euro and vice versa. The ECB Governing Council makes monetary policy decisions at meetings held eight times a year. Decisions are made by heads of the Eurozone national banks and six permanent members, including the President of the ECB, Christine Lagarde.

What is Quantitative Easing (QE) and how does it affect the Euro?

In extreme situations, the European Central Bank can enact a policy tool called Quantitative Easing. QE is the process by which the ECB prints Euros and uses them to buy assets – usually government or corporate bonds – from banks and other financial institutions. QE usually results in a weaker Euro. QE is a last resort when simply lowering interest rates is unlikely to achieve the objective of price stability. The ECB used it during the Great Financial Crisis in 2009-11, in 2015 when inflation remained stubbornly low, as well as during the covid pandemic.

What is Quantitative tightening (QT) and how does it affect the Euro?

Quantitative tightening (QT) is the reverse of QE. It is undertaken after QE when an economic recovery is underway and inflation starts rising. Whilst in QE the European Central Bank (ECB) purchases government and corporate bonds from financial institutions to provide them with liquidity, in QT the ECB stops buying more bonds, and stops reinvesting the principal maturing on the bonds it already holds. It is usually positive (or bullish) for the Euro.

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