Euro / Dollar May Have Bottomed, ECB Meeting to Set the Tone for the Exchange Rate Going Forward

The EUR has recently depreciated versus the USD and with theEuropean Central Bank meeting due this week that trend lower could be questioned.

All eyes will be on Thursday’s ECB governing council meeting which should set the tone for the shared currency over the remainder of the month.  

While we are expecting no change in policy, as the central bank looks to judge the effects of the aggressive package introduced in March, the press conference by ECB President Draghi should be closely watched.

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The euro is seen trading 0.15% higher against the US dollar than where it closed on Friday, however the exchange rate is well below the highs of 1.1465 recorded a mere 6 days ago:
 
However, looking ahead, this near-term downtrend is forecast to remain limited by analyst Andreas Hürkamp atCommerzbank who says uncertainty regarding the further course of action by the ECB and the Fed remains high.

Why has the Euro Exchange Rate Weakened of Late?

There are a couple of reasons for EUR/USD under-performance.

One reason being due to a general USD rally after the US currency had traded much weaker recently on the back of the more dovish Fed.

“But an extremely cautious Fed approach has now been priced in sufficiently. Moreover, several Federal Reserve Open Markets Committee members have struck a somewhat more optimistic tone of late,” says Hürkamp.

For example, Philadelphia Federal Reserve President Patrick Harker and San Francisco Federal Reserve President John Williams see a real possibility of up to three rate moves in the course of this year.

Further EUR/USD weakness is thus possible on account of the dollar's recent sell-off ending courtesy of a changing tone from the Fed. 

But the EUR also has domestic economic developments to blame for EUR/USD’s recent weakness.

“Against the backdrop of the disappointing development of inflation expectations in the Eurozone, the ECB will probably signal that it is still highly willing to take additional expansionary measures,” says Hürkamp.

In this context Hürkamp believes it is likely that ECB President Mario Draghi will make it clear that the ECB could indeed lower its interest rates further.

Draghi will feel he has cause to clarify his position, particularly following the last meeting where his comments on the outlook for Eurozone interest rates were interpreted differently by the market, which caused the EUR to appreciate.

“Although Draghi will surely deny that the package of measures adopted in March aimed to weaken the EUR exchange rate, the fact cannot be dismissed that the stronger EUR is not conducive to the ECB’s inflation efforts,” says Hürkamp.

Therefore, the market reaction seen at the time can hardly have been desirable.

It is worth pointing out though that although EUR-USD has risen by 2.3% since the previous ECB meeting (3.6% YTD), the TW exchange rate is up by a more-modest 1.0% (1.9% YTD).

This is due to the fact that, so far, the currency market has been dominated by the USD-weakness story, but it is relevant for the central bank as it is the Trade-Weighted index that matters most for international trade and therefore to inflation via the price of imports.

Thus it is a valid point that the ECB may not actively talk down the value of the euro.

Euro’s Downside Seen as Limited

The downside potential in EUR-USD remains limited near-term argue Commerzbank noting most market participants may remain sceptical as to whether the ECB can still ease its monetary policy at all.

“At the same time, they will not count on an imminent rate hike by the US Fed as long as they get no unambiguous signal from the Fed officials, for example in the statement after the next meeting on 26/27 April,” says Hürkamp.

The pair therefore looks set to maintain its recent technical ranges that are capped by 1.1450 to the top and 1.1250 at the bottom.