Can Expected ECB and Fed Cuts Balance EUR/USD

The ECB recently cut interest rates as expected, making the path forward less clear as analysts argue over the divergence between Europe and the United States.

After the Rate Cut

The ECB signaled for months that a June rate cut would occur, so markets were prepared. Inflation concerns and weak economic growth in Europe supported the rate cut. However, with the decision made, the balance of what comes next has shifted. Particularly since there have already been concerns about persistent inflation going into the meeting, and the Euro Area economy is in a very weak upswing that could very much use the help of lower interest rates. While the ECB Chief Economist Philip Lane previously backed a June cut, he is now less certain of additional easing.

Economists have maintained their predictions, however. A post-decision Reuters poll still showed 80% expectation of two more rate cuts this year, in September and December. If the Federal Reserve also cuts rates as expected in September and December, it would balance the effect of monetary policy on the EUR/USD exchange rate. However, this means that other factors, such as inflation and economic growth, could influence the currency pair more strongly.

In a Convergence Line

Over the past couple of years, inflation has largely defined fiscal and monetary policies. The US economy has shown resilience and above-expectation growth. Meanwhile, Europe has technically avoided recession. Now, analysts expect Europe's economy will finally accelerate as concerns rise the Fed will keep rates too high for too long, slowing the economy faster than it should. This could put Europe and US growth trajectories on a converging path.

Does this mean the EUR/USD could experience an unusually calm period? That assumes macro indicators in Europe and the US unusually align as central bank leaders remain "data dependent." However, the Fed and ECB expect inflation to remain above target next year despite rate cuts. So, constant confirmation of falling inflation is needed to maintain expectations - and, therefore, the currency pair. That is a high bar, which means small inflation variations could significantly impact the EUR/USD.

Symmetrical Triangle in Focus

While the recent ECB rate cut has caused the EURUSD to decrease slightly, an analysis of longer-term price action indicates that a potential symmetrical triangle pattern could be on its way to completion. Breaking below the $1.06 swing could invalidate the pattern or prolong its timeframe unless downward momentum accelerates the decline towards or under the 1.05 handle. Conversely, regaining the 1.0915 resistance may reinforce a move past 1.1141 and even 1.1280, with confirmation of the triangle structure enabling a measured-move progression to 1.15 and higher.

Source: SpreadEx / EURUSD

Key Takeaways

Inflation worries and weak growth in Europe supported the ECB's June cut, with most analysts still expecting two further cuts this year by both the ECB and Fed. However, balancing the policies' effect on the eurodollar with high inflation and a less straightforward outlook is challenging. While Europe's economy could accelerate, constant confirmation of falling inflation is needed to maintain expectations around EUR/USD.