EURUSD Set to Slide as Economies Diverge

Intermediate
  • ECB should have acted now; not delayed
  • The economic data in the Eurozone is weak and getting worse
  • The U.S. economy is coping incredibly well
  • The Fed will cut rates, but the ECB has a more urgent need to act

The ECB held interest rates unchanged at their meeting on Thursday July 25, 2019 with the main refinancing rate remaining at 0.0% and the deposit rate at -0.4%. I do not care for the fact that President Mario Draghi stated their intensions to ease policy later. He should have acted now. As ever with all things European, one wonders why the delay?

Still, we should not be surprised at the lack of action as the markets had priced as 50:50 the chance of a rate cut.

The currency pair fell to the lowest level since May 1, 2017 although a small bounce in the Euro has been seen back to 1.1135 as of 13:20 BST on July 26th. However, after the close in London that had slipped again to 1.1117 at 17:14 BST.

EURUSD One week Chart

Source: www.tradingeconomics.com, Spotlight Ideas

There are several reasons for the Euro’s value sliding and the ECB indicating a willingness to add further stimulus.

The Business Climate Indicator (BCI) for the Eurozone declined to 0.17 in June 2019 from 0.30 in the previous month. This was below market expectations of 0.23 and was the softest reading since October 2014. It is of no comfort to see managers’ production expectations, as well as their views on overall and export order books shrink. Similarly, their view on the ability to sustain an optimal level of inventories has deteriorated.

Manufacturing production in the Eurozone decreased 0.60% in May of 2019 over the same month in the previous year and critically economic growth in the region was confirmed at 1.2% in the first quarter of 2019, the same as in the previous three-month period and yet GDP growth seems tepid when compared to the U.S. at 3.2%. Even the U.K. that is bedevilled by Brexit is growing at 1.8%.

The annual inflation rate in the Eurozone rose to 1.3% in June 2019, slightly above a preliminary and market expectations of 1.2% as costs advanced at a faster pace for food, alcohol & tobacco and services. However, the ECB has used all the weaponry in its arsenal at the major problems it faces, i.e. low growth and low inflation. The whole reason behind having an inflation target of 2.0%, curiously termed “price stability” is that a small level of price appreciation, encourages consumption and business investment.

Looking beyond the Eurozone is not going to encourage any wider optimism as the European Commission summer economic forecast released on July 10, 2019 suggested that European Union (EU) is expected to expand by 1.4% and the Eurozone by just 1.2%.

Forecasts for Italy remained challenging as its economy will see the worst growth rate in the whole EU, just 0.7%.

The foreign-exchange markets will now be shifting their focus onto the U.S. Federal Reserve as the Fed is widely expected to cut rates at their meeting next week.

There is a view that the prospect of a declining interest rate differential between the U.S. and the Eurozone means that the Euro could be ready to stage a recovery in the form of a relief rally.

I think that might prove short-lived as the Q2 GDP growth figures have just been released for the U.S. These came at 2.1% cf. an expectation of 1.8%. That is what we should focus on and not be gloomy as growth slipped from 3.1% in Q1.

This was the last economic data point that could have impacted the Fed’s decision next week. I see the Fed acting; however, I do not think the need to cut rates in the U.S. is as pressing as it is within the Eurozone.

That to me suggests there will a medium-term decline in the level of EURUSD and I sense a fall as far as 1.0342 by year end cannot be overlooked. When the Euro falls, it will fall hard and fast.

EURUSD Three Year Chart

Source: www.tradingeconomics.com , Spotlight Ideas

Summary:

SELL EURUSD

Target 1 1.0869   Target 2 1.0342

Stop at 1.1600

Stephen Pope

Macroeconomic Strategist

Stephen Pope is the Managing Partner of Spotlight Group. He has worked in the world of finance since 1982 and has performed d...continued

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