EUR/USD extends upside amid uncertainty over ECB rate cuts beyond June

• EUR/USD rises above 1.0850 on a thinly traded day.
• The Euro strengthens as investors remain uncertain over ECB reducing rates in July too.
• Investors expect that the Fed will start lowering borrowing rates in the last quarter of this year.

EUR/USD jumps above 1.0850 in Monday’s European session after a calm start to the week ahead of the release of inflation data on both sides of the Atlantic on Friday. The major currency pair strengthens as European Central Bank (ECB) policymakers avoid to commit about extending the rate-cut cycle beyond the June meeting. 

ECB policymakers do not want to promise more rate cuts as they seem to be concerned that aggressive policy easing could revamp price pressures again. 

In this context, traders have dialled back expectations of three rate cuts this year and are seeing only two due to recent economic indicators signalling persisting price pressures, such as the Negotiated Wage Rates for the first quarter and the preliminary HCOB Composite Purchasing Managers Index (PMI) data for May.

Higher wage growth deepens households’ pockets, which leads to a significant rise in consumer spending that fuels inflationary pressures. However, ECB board member and Bundesbank President Joachim Nagel downplayed the effect of higher wage growth, stating that it is a lagging indicator and the long-term trend is expected to remain soft.

On the economic front, German IFO data on Business Climate, Current Assessment and Expectations for May has been released. The overall data missed estimates, however, the Euro remains unchanged. 

German IFO Business Climate Index dipped slightly to 89.3 from 89.4 in April. Investors forecasted a sharp rise to 90.3.

The Current Economic Assessment Index declined to 88.3 from 88.9 in April, missing the consensus of 89.9.

The IFO Expectations Index, which indicates firms’ projections for the next six months at 90.4, fell short of the market consensus of 90.5 but remains higher than the former reading of 89.7.

Daily digest market movers: EUR/USD rises as US Dollar drops

• EUR/USD moves higher above 1.0850 in a thin trading volume session on account of a holiday in United States markets due to Memorial Day. This week, volatility is expected to be high as the Eurostat is set to release the preliminary inflation data for May and the United States Bureau of Economic Analysis (BEA) will report the core Personal Consumption Expenditure Price Index (PCE) data for April. Both reports will be published on Friday.
• Investors will keenly focus on the Eurozone inflation data as ECB policymakers are widely expected to announce a rate cut in their monetary policy meeting in June, barring any surprise. ECB officials remain comfortable with market speculation for a return to policy normalization in June, but many are reluctant to commit to any subsequent move and want to remain data-dependent.
• The expectations for the Eurozone preliminary inflation report suggest that the annual core reading – which strips off volatile items like food, energy, tobacco and alcohol – will remain steady at 2.7%. The headline figure is estimated to have accelerated to 2.5% from 2.4% in April. The inflation data isn’t likely to significantly impact the rate-cut decision for June.
• Meanwhile, the US Dollar drops in the early European session, extending the steep sell-off of Friday. The US Dollar Index (DXY) fell to 104.60 despite investors losing confidence in the Federal Reserve (Fed) beginning to lower interest rates in the September meeting.
• The CME FedWatch tool shows that traders see a little over 50% chance that the central bank will keep interest rates unchanged in September, up from 38% last week. The odds leaning towards keeping rates on hold have been driven by a surprisingly strong preliminary US PMI report for May.
• This week, the core PCE inflation data will influence market speculation for Fed rate cuts in September. The Consumer Price Index (CPI) data for April, which was published earlier this month, showed price pressures cooled after a hot first quarter. This deceleration suggests that the core PCE, the Fed’s preferred inflation measure, will also have softened from its prior reading of 2.7% on a year-on-year basis.

Technical Analysis: EUR/USD clings to triangle breakout

EUR/USD consolidates around 1.0850 ahead of crucial inflation data for both the Eurozone and the US. The major currency pair indicates broader strength as it strongly holds the breakout from the Symmetrical Triangle chart pattern formed on a daily time frame. 

The near-term outlook of the shared currency pair remains firm as it is trading above all short-to-long-term Exponential Moving Averages (EMAs).

The 14-period Relative Strength Index (RSI) has fallen into the 40.00-60.00 range, suggesting that the upside momentum has faded for now.

In case of further upside, the major currency pair is expected to recapture a two-month high at around 1.0900. A decisive break above this level would drive the asset towards the March 21 high at around 1.0950 and the psychological resistance of 1.1000. However, a downside move below the 200-day EMA at 1.0800 could push the pair further down.