This week, the euro experienced an unexpected decline. It fell during the same two weeks that the European Central Bank (ECB) opted to raise interest rates for the first time since 2023. The EUR/USD dipped to around 1.1400, hitting multi-week lows, before rebounding slightly to approximately 1.1450. This situation highlights an important point: not all interest rate hikes indicate confidence. The ECB’s decision to tighten monetary policy wasn’t necessarily due to a struggling eurozone economy, but rather a reaction to the ongoing energy crisis. This distinction reveals why the euro isn’t effectively encouraging central banks to adopt more aggressive stances.
A hike that feels more like surrender
The ECB’s actions clarify its limited options. By raising deposit rates for the first time in nearly three years while simultaneously cutting growth forecasts and raising inflation expectations, it’s signaling an environment of stagflation. Even though the eurozone economy shrank in the first quarter, inflation soared to its highest in nearly three years primarily because of rising energy prices linked to disruptions in the Strait of Hormuz. Tightening monetary policy under these circumstances seems more a defensive maneuver. Currency markets can distinguish when central banks raise rates due to actual strength versus necessity.
A struggle across the Atlantic
When considering interest rate differentials, the euro is currently at a disadvantage. The ECB’s rate hike came with guidance indicating that there wouldn’t be a clear trajectory forward, which traders interpret as a one-time adjustment rather than the beginning of a series of hikes. Meanwhile, German federal bond yields barely budged. On the other hand, the Federal Reserve kept its rate steady at 3.75% but adjusted its projections to account for expected hikes, boosted by stronger economic indicators, while the dollar index reached a 13-month peak. When both central banks adopt a hawkish stance, the currency linked to a more robust economy typically prevails. At this moment, that’s decidedly the U.S. dollar.
Keeping short-term expectations in check
Short-term market conditions lend some support to the euro, though that might feel just. Prices have broken below the interim floor of 1.1450, and the Hourly Stochastic Relative Strength Index (Stoch RSI) is now in overbought territory after a recovery, hinting at limited immediate movement. While this might offer a temporary rally, a correction toward the 1.1500 area seems plausible. However, the daily chart indicates prices are below both the 50-day and 200-day exponential moving averages (EMAs), centered around 1.1600, signaling an overall bearish trend.
Upcoming Purchasing Managers Index (PMI) readings and remarks from ECB officials won’t likely change this outlook. Should the euro begin to recover, it may struggle to maintain that momentum ahead of next Thursday’s anticipated U.S. economic data release. This will include the third estimate of the first-quarter gross domestic product (GDP) and the May personal consumption expenditure price index (PCE) at 12:30 p.m. Japan time.
Resistance levels to watch include the 1.1500 area first, followed by 1.1550. A more significant hurdle lies around 1.1600, where the 50-day and 200-day EMAs meet, and any recovery must prove its strength.
Support becomes critical with the interim lower bound around 1.1450 being crucial for bulls to defend. If it breaks below that, the 1.1400 mark, which represents this week’s lows, will come into play. A clear breach here could set off a renewed downtrend.
In terms of market bias: it’s tactically neutral, with the potential for a short-term upswing toward 1.1500, as long as 1.1450 holds. Yet, a longer-term bearish outlook remains. The euro is still significantly influenced by the dollar. A rise in U.S. PCE next week could likely send it back under 1.1400, unless we see a favorable U.S. inflation report that would genuinely rejuvenate the euro.
