Euro vs U.S. Dollar
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EUR/USD Forecast: Euro May Break Lower vs. U.S. Dollar as Inflation Cools

By:Ilya Spivak

The euro may drop below 1.07 against the U.S. dollar as progress on inflation moves up the ECB rate cut timeline

  • Progress on Eurozone inflation has set the stage for ECB stimulus.

  • Soft CPI data may accelerate the timing of the first rate cut to April.

  • The euro may be ready to break below 1.07 against the U.S. dollar.

The euro has slid back to the bottom of a range that has contained it for the better part of four months, anchored above 1.07 against the U.S. dollar.

That performance follows repricing of Federal Reserve monetary policy expectations. Traders have slashed rate cut bets after a run of strong economic data and hawkish comments from Fed Chair Jerome Powell.

Incoming Eurozone consumer price index (CPI) data looks likely to add fuel to the fire. While headline inflation is expected to hold at 2.6% year-over-year for the second consecutive month in March, the core rate excluding volatile food and energy prices is marked for a decline. Experts expect it to fall to a two-year low of 3%.

Incoming Eurozone consumer price index data
Data source: TradingEconomics, Eurostat

Baseline forecasts for German numbers due to cross the wires a day ahead of the region-wide report are likewise tilted to the downside. CPI harmonized to the use the same methodology as the European Central Bank (ECB)—a more policy-relevant measure than domestic calculations—is expected to slip to 2.4%, the lowest since November 2023.

Inflation progress sets the stage for ECB rate cuts

Disinflation appears to be broadening.

The impact of food prices—the largest upside contributor to overall inflation in 2023—has narrowed to the smallest since November 2021. More of the same looks likely ahead as global food costs continue to decline, showing up in CPI with a lag of about seven months.

The top problem area is now the hospitality sector. This seems likely to unravel as economic weakness takes its toll. The latest purchasing managers index (PMI) data showed Eurozone economic activity contracted for a ninth consecutive month in March as deterioration in the manufacturing sector offset a slight pickup on the services side.

Eurozone ESTR Futures-Implied Policy Rates
Data source: ICE

As it stands, investors expect the ECB to deliver 88 basis points (bps) in interest rate cuts in 2024. That adds up to three reductions at the standard clip of 25 bps each and a 48% probability of a fourth one. Benchmark ESTR interest rate futures imply the first move will arrive in June, and rest between September and year-end.

Euro vulnerable at key level against the U.S. dollar

Analytics from Citigroup reveal that Eurozone economic data outcomes have soured relative to forecasts over recent weeks. If that sets the stage for downside surprises on CPI releases, the probability that that the ECB might cut rates as soon as this month is likely to grow. It is now at a slightly less-than-even 44%.

That would bode ill for the euro. A break of inflection support at the 1.08 figure exposes the range bottom in the 1.0709-28 zone. Falling below that looks likely to set the stage for a test of the 1.06 mark, followed by the major swing bottom below 1.05. Alternatively, reclaiming a foothold above 1.08 may put the 1.09 mark back in view.

Eurozone Economic Data
Data source: tastytrade

Ilya Spivak, tastylive head of global macro, has 15 years of experience in trading strategy, and he specializes in identifying thematic moves in currencies, commodities, interest rates and equities. He hosts Macro Money and co-hosts Overtime, Monday-Thursday. @Ilyaspivak

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