The EUR/USD currency pair stormed the 1.10 level yesterday, reacting to the results of the December meeting of the European Central Bank (ECB). The divergence in monetary policy between the ECB and the Federal Reserve favors EUR/USD buyers, although just a few months ago, this factor exerted significant pressure on the pair.
Not long ago, the Federal Reserve demonstrated a hawkish stance, contemplating another round of interest rate hikes, while the European Central Bank voiced very cautious comments, essentially stating that the ECB would keep rates at the current level, but no higher. Looking at the monthly EUR/USD chart, we can see that the pair began a steep descent in August, dropping from 1.1062 to 1.0449 in October. However, in late autumn, the fundamental picture began to gradually change, primarily due to the slowdown in inflation in the United States.
All inflation indicators for October and November came out in the "red zone" or at the forecast level, reflecting a decline in inflation. After that, the market began to speculate that the Federal Reserve would start easing monetary policy early next year. However, until the December meeting, there was still some intrigue, as de facto inflation was still quite far from the two percent target level. As known, the Fed members eventually implemented the most dovish scenario, allowing a 75-basis-point rate cut in the next year, according to the updated dot plot.
It is noteworthy that inflation in the eurozone is also showing a downward trend—for example, all indicators of the November CPI came out in the red zone. However, the European Central Bank maintained a hawkish stance, stating that inflation would temporarily accelerate again in the near future.
It should be noted that in the run-up to the December meeting, most experts stated that the ECB would likely soften its rhetoric regarding the further prospects of monetary policy. In the expert community, there was often the opinion that the first interest rate cut would happen "before the summer of 2024."
This confidence favored EUR/USD buyers, as ECB President Christine Lagarde refuted such intentions by the regulator. She stated that there were no discussions about easing monetary policy at the December meeting. Moreover, according to her, interest rates will remain at the current level "at least in the first half of next year." Thus, she postponed all talks about easing monetary policy to a later date.
The regulator indicated that it would take into account the cumulative volume of monetary policy tightening from meeting to meeting and the lagging effects of monetary policy, acknowledging that past interest rate hikes continue to significantly influence the eurozone economy. In the accompanying statement, the central bank also stated that economic growth would remain suppressed in the near term, but it is expected that the economy will recover due to the growth of real incomes.
According to updated forecasts, the pace of economic growth will increase from an average of 0.6% in 2023 to 0.8% in 2024 and to 1.5% in 2025 and 2026. As for inflation, the regulator pointed out that it would gradually decrease throughout the next year. According to the forecast, inflation will only approach its two percent target in 2025.
After the meeting, European Central Bank Governing Council member Madis Muller confirmed that the regulator does not plan to consider easing monetary policy in the foreseeable future. According to him, it is still too early to talk about a rate cut in the near future, as it is still too early to celebrate victory over inflation. He also reiterated one of the key messages of the December meeting, stating that the path to achieving the target inflation level is "rocky and bumpy" and, most importantly, quite long.
In other words, the actual decoupling of monetary policies between the ECB and the Federal Reserve is playing into the hands of EUR/USD buyers. Today's price pullback is due to two reasons: firstly, the infamous "Friday factor," and secondly, the red PMIs. For example, the business activity index in the German services sector fell to 48.4 points, with a forecast of a rise to 49.9 (although the business activity index in the manufacturing sector increased to 43.1 after a decline in November to 42.6).
However, considering the established fundamental background, it is still not advisable to "trust" downward price pullbacks. Typically, after upward impulsive movements, a downward correction follows (and vice versa), which we are currently observing. Both "fundamentals" and "technicals" favor long positions. The pair on the daily chart is between the middle and upper lines of the Bollinger Bands indicator, as well as above all lines of the Ichimoku indicator, demonstrating a bullish "Parade of Lines" signal. The initial, and so far, the main target of the upward movement is the level of 1.1030, which corresponds to the upper line of the Bollinger Bands on the D1 timeframe.
