The EURUSD has revered to a downward trend over the last week, mostly as a result of dollar strength. But on the European side, there doesn’t seem to be much that could help arrest the fall. That is, if the dollar continues to gain.
The peak in the currency pair can largely be attributed to the trade situation. Which means that as the markets feel that trade is normalizing, then the gains could be reversed. At a certain point the widening interest rate gap between the economies should reassert itself. With increasing pressure to the downside, is there anything that could change to bring the pair back up?
The Economic Factor
On Thursday, the Euro Area will provide a second reading of its Q1 GDP figures, which are expected to illustrate the underlying problem. The preliminary measure showed growth accelerating to 0.4% from 0.2% in the final quarter of last year. On an annual basis, that’s an improvement to 0.8% from 0.7%. Those figures are expected to be confirmed, though a revision is possible and could cause some anxiety in the market if they are revised lower.
While headlines focus on the fact that the growth rate increased, it is still a very meagre performance. Arguably, the economy should be growing at at least 2% per year to achieve the target inflation rate. The EU is advancing at less than half that pace, implying that inflation could face further downward pressure from an almost stagnant economy. Organic inflation (that is inflation that isn’t caused by external factors such as money printing or tariffs) relies on increasing the speed of money in circulation. If there isn’t enough economic acceleration, then it’s increasingly harder for the central bank to reach its inflation target.
More Cuts Ahead
With this in mind, a recent survey of economists from Bloomberg showed an expectation that the ECB would cut more than previously thought. Many officials in the shared central bank had mentioned an interest rate of 2.0% as around neutral, implying that is where rates are expected to be cut to.
But, economists point to the slow growth and improving trade situation as a sign that the ECB might have to cut at least one more time than previously thought. That would bring the interest rate below 2.0% and widen the gap between the final interest rate expected for the dollar this year. That would total 9 quarter-point cuts for this year, as opposed to the 7 at most expected from the Fed. In other words, the interest rate gap between the two economies would be 50 bps higher, implying that the Euro should be weaker than the dollar by the end of the year.
And the Good News?
Interest rates aren’t the entirety of the story, however, as the Euro rising in the midst of the trade war shows. The recent losses in the EURUSD have come on the back of improved optimism around the tariff situation, and hopes that the US economy won’t be as affected. However, the tariff situation remains fluid and markets are reacting to expectations of further deals.
If those deals don’t materialize, then the dollar could weaken again, and give the EURUSD a boost. However, the dynamics from the Euro side remain likely to the downside. So the performance of the pair might be more related to whether or not the dollar is weaker than whether the Euro is stronger.
